| Common
Misconceptions About Employee Stock Options
In their
article “Employee Stock Option Valuation: New Source
of Litigation Risk for Auditors” (Perspectives, August
2004), authors Cindy W. Ma, Algis T. Remeza, and Daniel LaGattuta
posit a myth about employee stock option (ESO) valuation:
that there is a disconnect between the value of option-based
compensation to employees and the cost of the same compensation
to the company. This is not the first time I have heard this
distinction being raised, and its perpetuation is troubling.
In
other corners of the valuation world, such controversies
have long been addressed by privileging the concept that
value is “value received.” For example, assume
a company generates a technology that it cannot use. The
company opts to donate that technology to an institute that
needs it. In such a case, the technology is essentially
valued for what it is worth to the ultimate user, not for
its worthlessness to the donor. Similar logic applies here.
Furthermore,
why would a company engineer a compensation system that
costs the employer more than it benefits the employee? For
a long time, ESOs were considered to be more or less costless
to the company but of great value to the employee. Some
apparently still think that way, but the general discrediting
of that logic has led FASB to where it is today. Now we
have the opposite and equally dysfunctional argument, that
somehow ESOs are more economically costly to the company
than they are beneficial to the employee. Conceptualizing
a compensation expense to the company that is different
from the value received by the employee violates the spirit
of SFAS 123.
The
principle of equating compensation costs and benefits has
led to changes in accounting standards; valuation of ESOs
should recognize this symmetry.
Matthew
R. Crow, CFA, ASA
Senior Vice President, Mercer Capital
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