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Case Assignment
Case: Sally Jameson: Valuing Stock Options in a Compensation
Package
Instructions: Work in groups of 3. Hand in typewritten solutions with
no more than 3 pages. The first and third question is worth 20 points, while
the remaining are worth 10 points each.
1. If we ignore tax considerations and assume that Sally Jameson is free to
sell her options at any time after she joins Telstar, which compensation
package is worth more? NOTE: we have not discussed warrants in
this class. Since the grant is quite small relative to the number of
shares outstanding, we can treat the grant as an option rather than
a warrant, which explicitly accounts for the increase in the number of
shares awarded.
2. Calculate the delta of the option.
3. Now suppose Sally is not allowed to sell the options. Moreover, she
will lose the options if she decides to leave the company. Ignore any
tax complications.
(a) Assuming a volatility estimate of 45%, what assessed risk-neutral
probability of Sally staying on at Telstar for 5 years, if any, would
make it worth her while to accept the option grant over cash?
(b) If the volatility estimate was 30%, same question as above. Is
the probability higher in (a) or (b)? Provide a short statement
to explain the intuition on why.
(c) Are there any strong assumptions you have to make in this calculation about her length of tenure for this calculation to be valid?
4. Consider the following statement: Since the cash bonus is a sure thing
and the option grant is a risky compensation, we cannot simply compare the two values directly. Answer this question first by assuming
that Sally is free to sell her options at any time after she joins Telstar
and then with the restriction that she can only exercise after 5 years.
Is the statement true/false/uncertain. Provide a short reasoning.
5. Consider the following statement: The tax implications for options are
more uncertain than for the cash bonus. Is the statement true/false/uncertain?
Provide at least two concrete reasons that will support your choice.

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6. A cynical point of view with option granting is that the firm may
terminate employees just before their in-the-money options become
exercisable. What feature do we see in options granted that will control
this kind of action by the firm?
7. What if Ms. Jameson decided that the option was a better deal, but
she did not want a substantial part of her financial wealth (as well as
her human capital) tied to the fortunes of Telstar? What measures
could she take to untie some of her wealth from Telstar? Explain
the complications she would face.
8. How can managers (such as Sally Jameson will be in the future) increase the value of their option grants once they get into decision
making roles in the company? What financial contract might be a
better way to compensate managers in this context?