If such adjustments were permitted the committees

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Unformatted text preview: fair value objective. If necessary, the standard could provide factors to consider in determining fair value, such as: • The exercise price of the option • The current price of the underlying security • The expected life of the options, the period over which the options will actually be outstanding • The anticipated risk-free interest rate for the period corresponding to the expected term of the option • The expected future volatility of the underlying security • Expected dividends • The effect on value of the lack of transferability of the options • The effect on value if the stock cannot be sold, once the option is exercised, because of a blackout period. The quality of the assumptions used in option pricing models is critical determining an appropriate fair value. 72 The Committees solicited the views of valuation experts on the parameters that should form the basis for a fair value requirement and were advised that in order to estimate fair value, companies should have the ability to: • use the probability distribution of an option's lifetime, as estimated from historical data, rather than its expected value only; • employ a stochastic model for volatility, calibrated to historical data; • apply models other than standard geometric Brownian motion to describe the uncertainty in the temporal evolution of share prices into the future, provided empirical evidence can be produced that supports them. If such adjustments were permitted, the Committees also would agree that it would be appropriate to provide disclosures that help investors understand the model that was used and the methodologies applied for determining the assumptions. 4.5 Overview of Company Reporting Practices We have chosen ten companies to look into their stock based compensation accounting practise. We investigate their views expressed in the Comment Letters compared to what they do in practice. All the companies we are reporting on are included as a respondent in one of the Comment Letters categories. We do not include all the companies because eleven of them are the entities (The Boston Security Analysts Society, The Software & Information Industry Association, etc.) that represent their members’ view but they do not practise stock based compensation accounting themselves; one company has bankrupted during the period 1993-2003 (LTV Steel) or two companies have merged (The Chase Manhattan Corporation and JPMorgan). We are looking at the latest available annual reports of the companies. 4.5.1 The Shell Petroleum Company The philosophy of remuneration of Group Managing Directors in the Shell Petroleum Company (Shell) is to attract and retain highly experienced individuals a nd m otivate t hem t owards h igh-quality p erformance. T he remuneration systems are therefore developed to reconcile the goals of senior staff to those of the company and shareholders. A significant proportion of remuneration packages is linked to actual performance. Group Stock Option Plans are a means of long-term incentives. Shell grants stock options plans once per year in accordance with one of the Group Stock Option Plans. Since 1998 Shell granted stock options to executives for a ten73 year term. The vesting period is usually three years and 50% of the options are subject to various performance conditions. In the Annual Report 2001 Shell states that the shares granted under Group Stock Option Plans are existing issued shares of the company. Hence, no dilution of shareholders’ equity exists. The price at which shares can be bought (the exercise price) will not be less than the fair market value of shares at the grant date. Shell does not show the stock option expense in the income statement. The Group Consolidated Financial Statements are prepared in accordance with Dutch GAAP. Shell stated in its Comment Letter that as long as the requirement to expense employee stock options is not universal, requiring European companies to expense them, will put them into more disadvantaged position. As there is no requirement to show the stock-based compensation expense measured at its fair value under Dutch GAAP, the company only provides the disclosure in the footnotes to the financial statements. However, in our opinion, there is an opportunity cost for the company. In 2001 the number of options exercised was 16,000 EUR. The exercise price was 48.92 EUR, while the market price at a date of exercise was 67.26 EUR. In the United States, the subsidiary of Shell prepares its financial statements in accordance with U.S. GAAP. The company, however, does not apply the fair value based method of accounting for stock-based compensation expense. It only provides disclosure as required by SFAS 123. In the notes to the financial statements, it is simply written that the pro forma impact on net income and earnings per share calculated according to SFAS 123 requirements is not significant. Shell's reluctance to include employee stock-based compensation expense in the income statement can also be based on the company's distr...
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