Does Stock Return Predictability Affect ESO Fair Value?

We study the effects of the predictability in stock returns for the fair value of American Executive Stock Options (ESOs). By assuming a trending Ornstein-Uhlenbeck process for stock returns, we solve for the executive's optimal exercise policy using a methodology based on the least-squares Monte Carlo algorithm. We find that executives tend to wait longer the higher the predictability, independently of the executive's asset menu. We also analyze the implications of following the FAS123R proposals in the computation of the ESO's fair value