No More Scandals: A Simple Model For Valuing Employee Stock Options

Abstract

The escalating size of compensation packages to senior managers and investor disillusionment have resulted in growing calls for the expensing of employee stock options (ESO).  While initially slow to respond, the FASB has now mandated the expensing of ESO.  The two primary methods used to value ESO, the Black-Scholes closed form equation and the lattice model, suffer from several deficiencies  .A Simple model for valuing ESO that marks the option expense to market in succeeding financial statement dates and allows for the staggered exercise dates of option holders is available. The model is easy to understand, would have a low cost of implementation, and offers a superior estimate of the true cash flow effects associated with the opportunity cost to shareholders of ESO exercise.