Many companies are recognizing that the Black–Scholes formula is
inappropriate for employee stock options (ESOs) and are moving toward lattice
models for accounting or decision-making purposes. In the most influential of
these models, the assumption is that employees exercise voluntarily when the
stock price reaches a fixed multiple of the strike price, effectively
introducing a “horizontal” exercise boundary into the lattice. In
practice, however, employees make a trade-off between intrinsic value captured
and the opportunity cost of time value forgone. The model proposed here
explicitly recognizes and accounts for this reality and is intuitively
appealing, easily implemented, and compliant with U.S. accounting standards.