Academic Research: Employee stock option valuation in mergers and acquisitions: Story of lost time values - 2 July 2010

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PURPOSE OF THE STUDY. The purpose of the study is to show how target
employee stock options (ESOs) are valued in mergers and acquisitions,
and to answer whether the possibility of company being bought should
affect the stock option values. I also investigate whether the valuation
methods used in transactions retain the total value of ESOs including
both the intrinsic and the time value components, what factors determine
the choice of valuation method, and what are the implications of
different methods to the option valuation.



DATA. Data set consists of option valuation method observations in
mergers and acquisitions in 2008 and 2009, in which the target is
publicly listed on either NYSE or Nasdaq. Total number of transactions
in the sample is 381, and the number of option valuation method
observations is 316 after excluding observations with no information
available.



RESULTS. Findings of the study show that two main valuation methods
emerge. Usually, target option holders receive the intrinsic value of
options (the offer value over the exercise price) and the options are
forfeited, or then the options are converted to new options of the
acquirer or the surviving corporation. Options are more likely to be
converted if transaction is paid in stock, when the transaction value is
high, and when the acquirer is publicly listed or based in the US.



Converting options retains the time value of options and therefore
generally retains or increases the option value. Paying the intrinsic
value and forfeiting options may result to either lower or higher option
value, and the outcome is mainly driven by the takeover premium and
option moneyness. For instance, in 21% of the cases when the intrinsic
value is paid, the strike price of all options exceeds the offer value
and the payoff to the option holders equals to zero. Findings suggest
that ESO valuation in corporate transactions can have a significant
effect on option value and therefore it should be in incorporated into
the valuation models.