The Effect of Cliff Vesting on Employee Stock Option Values

Employee stock option values can change wildly over time.

Participating in a cliff vesting employee stock option program can make you very impatient to exercise your options. However, there is a hidden value for your wait.

Employee Stock Options

The main feature of employee stock options is the right, but not the obligation, to buy or sell company stock by a specified expiration date. The basic value calculation of a stock option is the difference of its set exercise price and the market value of the stock.

Cliff Vesting

When you are cliff vested, it means you can't exercise the total amount of options you were awarded until a specified date. This is opposed to ratable vesting where you incrementally gain greater access to your full option grant year after year.

Cliff Vesting and Employee Stock Options

Stock option value is also determined by proximity to its expiration date. The greater the time before the option's expiration the more time-value it has. Because cliff vesting delays the full possession of employee stock options, the expiration date of those options is also delayed. The result is that cliff vested employee stock options retain a greater value than those vested through other time lines.

References

• Financial Web: The Value of Employee Stock Options
• Financial Web: The Definition of Cliff Vesting
• The CPA Journal: Valuing Employee Stock Options Using a Lattice Model