The valuation of executive stock options (ESOs) depends not only on whether the stock price exceeds a strike price, but also depends on whether the firm value is sufficient to cover debt repayment and salary compensation owed to employees. We propose an option pricing model for ESO contracts with a risk generated from the option writer's potential for defaulting. This study focuses on the analysis of valuations, executive incentives, firm defaults, and the two parties' respective strategic behaviors. We support that executives have incentives to enhance contract value by increasing their effort or risk-taking, but these incentives are correlated to the design of the contract and a firm's strategies. If the total of debt repayments and salary compensation is greater, the firm has a greater likelihood of defaulting on the ESO contract.