>> an exercise-and-hold-all-shares transaction being tantamount to buying more shares (because of the need to satisfy the tax liability) is exactly the point
Well in that case it would be more efficient to not exercise and simply take the "tax money" and use it to actually buy more shares.
The issue here is that neither the execs nor their advisors likely have a clue as to what the truly optimal thing to do is given the assumption that the stock is headed up. But the "intuitively optimal" thing to do is "clearly" to exercise and hold, and so that's exactly what they do.
To the extent we are trying to deduce the executive's beliefs based on their executing an exercise and hold, I think it is legitimate to assume they have this (mistaken) belief that they are behaving optimally.
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