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Unformatted text preview: existing option pricing models. They find them to be inappropriate for
valuation of employee stock options. It is often underlined that assumptions
used in the Black-Scholes and binominal option pricing models have to be
modified when applying them to employee stock options. The modifications
made would be company-specific and rather subjective. Hence, the ultimate
results would be incomparable across companies. Providing disclosure about
the assumptions made when using option pricing models would give deeper
insight into how companies calculated stock option expense. But even
extensive disclosure does not eliminate the necessity of introducing updated
and more comprehensible and employee stock options specific models to
measure stock-based compensation expense.
As for the date of measuring the stock-based compensation expense, all
responding companies agreed that grant date is the most appropriate as this is
the date when all parties involved agree on the transaction and its value.
5.2.4 Invitation to Comment
The main issues recurring in basically every Comment Letter we reviewed
included the following:
Issuance, Forfeitures, and Attribution Methods
Some companies disagreed with the units of service model proposed in the
IASB ED because of inconsistency of a conceptual basis for the IASB
attribution model. The concern was also expressed about the possibility that
expenses recognized under the units of service approach can actually exceed
the fair value of options granted. These outcomes stretch the credibility of the
To the question of whether the effect of forfeitures should be incorporated into
the estimate of the fair value of options granted, companies believed that
Statement 123’s approach, which excludes forfeitures from the estimate of the
fair value of options granted, is the preferable approach. Requiring issuers to
estimate future forfeitures and to incorporate that estimate into the option
pricing model would enable them to “manage” the fair value of options granted
and related compensation expense by adjusting their estimates. Furthermore,
the IASB approach would not allow issuers to adjust compensation expense for
85 any variance between estimated and actual forfeitures. In addition, the
proposed IFRS is overly complex, will prove difficult to track, and will not
yield estimates that are more accurate than the straight-line or graded vested
methods under Statement 123.
Option Pricing Models / Valuation of Employee Stock Options
The accounting standard should require the use of an appropriate option-pricing
model for footnote disclosure. The model used, including key assumptions and
the basis for selecting a particular model, should be clearly disclosed in the
footnotes. The Black-Scholes model often can produce misleading results for
companies with stocks that are highly volatile and/or have limited liquidity.
According to SFAS 123, there is limited quality guidance for determining the
volatility assumption and no consideration of adjustments in value for
companies with thinly traded stocks. Adjustments need to be allowed for these
factors to provide for a more accurate determination of fair value. Employee
stock options are non-transferrable and subject to forfeiture, which reduces
value. These factors are not considered in existing models, leading to an
overstatement of value.
Companies underlined that FASB and IASB should not mandate the use of a
particular option pricing model and companies should be permitted to use
professional judgment in deriving their best estimate of each of the relevant
variables consistent with the fair value objective.
Companies suggested 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 companies 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
Companies expressed their views that improved disclosures are meaningful to
shareholders and users of the financial statements. The current concern is that
the stock option disclosure could become too lengthy and complex for
86 shareholders and other users of financial statements. Some companies
supported the IASB's suggestion to provide additional disclosure surrounding
key assumptions (volatility and vesting conditions).
5.2.5 Practice of Accounting for Stock-Based Compensation Expense
When looking at the annual reports of companies and the methods used to
measure stock-based compensation expense, we found that the...
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This document was uploaded on 10/31/2013.
- Fall '13