Many studies use the book value of debt as a proxy for its market value because most corporate debt does not trade. I call this practice the book value of debt (BVD) approximation, and it appears to be justified by the observation that the average market value of debt is close to its book value. Many corporate bonds, however, trade at values significantly different from their book values, and consequently the BVD approximation can create important biases. I compare the accuracy of the BVD approximation to Merton's option pricing (OPT) model of corporate debt valuation, and find consistent evidence that the Merton model provides more accurate estimates. I also show that this model is an easily estimated alternative to the BVD approximation. In short, the BVD approximation not only creates significant biases, but it is also an unnecessary simplification.

Previous studies ignore the fact that employee stock options are warrants because these options have been an insignificant component of firms’ capital structures. I show that this assumption is no longer correct. For example, for more than 36% of my sample firms, employee stock options represent a more significant claim on firm value than the firm’s debt and preferred stock combined. Moreover, in contrast to the suggestions of previous research, I show that employee stock options are a significant claim on firms throughout the economy, including larger firms, older firms, and firms in “Old Economy” industries. Finally, I show that the presumption in prior studies that employee stock options are not warrants causes a potential misunderstanding of the risk-shifting interests of securityholders and biases the analysis of capital structure issues.