A reload feature automatically grants new options to

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Unformatted text preview: ptions can change hands, but won’t be exercised ahead of time. In case of employee stock options, if the holder of the option wants to divest it, there is only one alternative, i.e. to exercise the option, even if the time is not appropriate a nd t he v alue r eceived w ill b e l ess t han o ptimal (www.ei.com/publications/2001/winter). In addition, employee stock options can have a reload feature, which traded options do not have. A reload feature automatically grants new options to an executive when original options are exercised. The exercise price of the option with a reload feature is usually equal to the market price of the company’s shares at the date when the original options are exercised. An option with a reload feature is more valuable than a conventional option. The holder of the reload option has the benefit of exercising existing options and still having options for future exercise (Saly & Jagannathan, 1999). Thus, the right option pricing model which would correctly estimate the value of employee stock options is the one which could be adjusted considering the unusual nature of employee stock options. Another problem with the measurement of stock options is the problem of the exercise period. The question is whether to measure stock options at a grant date or vesting date. If the measurement date is the grant date, then what would be the fair value of the stock option, which the employee may exercise in five or ten years, or maybe never? (Cheatham, 1995). The possibility of early exercise of stock options makes the issue of stock options measurement more challenging. Employees may choose to exercise their options prematurely in order to eliminate their exposure to risk. Therefore, in order to reduce the errors in measurements, it will be necessary to eventually adjust the estimated expense if the actual terms differ from those estimated (Hemmer & Matsunaga, 1994). FASB and IASB are aware of this problem. Due to possibility of early exercise, both SFAS 123 and Exposure Draft 2 require the stock options to be valued based on the expected life of the stock options rather than their contracted lives. 31 3.6 Accounting for Stock-Based Compensation in the United States Prior to SFAS 123 Accounting for stock-based compensations has long been a controversial issue. Two questions have dominated the standard setting process in the area of stockbased compensations: Should compensation expense be recognized for stock options? I f y es, o ver w hich p eriods s hould i t b e a llocated? (www.nysscpa.org/cpajournal/2001/0500/ features). In October 1972, Accounting Principles Board (the APB) in the United States issued Opinion No. 25 (APB 25) “Accounting for Stock Issued to Employees.”. APB 25 measures compensation on the intrinsic value of the granted options. The intrinsic value of an option is defined as the difference between its exercise price and the current price of the given stock at any point during its life (Brozovsky & Kim, 1998). Under APB 25 the amount of compensation is determined at the measurement date. The measurement date is the first date on which both the number of the shares the employee will receive and the exercise price are known. Usually, this is a grant date (Brozovsky & Kim, 1998). But at a grant date the market price and exercise price are normally the same. Therefore, corporations do not recognize any compensation expense related to stock options (www.orgs.comm.virginia.edu/ mii/education/Funda mentals). 3.7 The History of SFAS 123 “Accounting for Stock-Based Compensation” The accounting professionals were not satisfied with the approach allowed by APB 25 as it ignored the possibility that one day the stock price might be higher than the exercise price. FASB worked for eleven years (1984-1995) to develop a new standard (www.fwcook.com). In 1993, FASB issued an Exposure Draft of a new standard, which required the companies to measure the expense of stock options at their fair value and show it on their income statement. However, the business community firmly objected to the Exposure Draft. Eventually, in October 1995, FASB released Statement of Financial Accounting Standard No. 123 “Accounting for Stock-based Compensation” (www.online.wsj.com/article). SFAS 123 allows, but does not require, companies to use the fair value method to measure the compensation expense. Under the fair value method, companies have to measure compensation expense at a value of an award on a date it is granted. Companies are allowed to continue using APB 25, but have to provide disclosure of the effects SFAS 123 would have on their net income and earnings per share. Due to this disclosure rule, every company which is offering employee stock options must perform the calculations required by SFAS 123 (Brozovsky & Kim, 1998). 32 In the wake of the U.S. accounting scandals of 2001-2002, more and more companies chose to expense the cost of employee stock options. As late as mid July of 2002 only two companies between the Standa...
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