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Challenges for Companies in Valuing Options: As companies face the prospect of having to expense the cost of employee stock options, it's important for them to understand the ins and outs of option pricing.

Article Excerpt
In the wake of the recent accounting scandals, there has been a lot of talk about employee stock options, largely centered on whether companies should expense them. Proponents of the expensing of stock options are pushing for a uniform accounting treatment for options, saying that they are a compensation expense which should be reflected in companies' financial reports.

Less discussed has been the issue of how much employee stock options are actually worth. Assessing the fair market value of options can help companies understand the impact that the options expense has on earnings, and figure the true cost of employees' compensation packages. For companies being primed for an IPO, careful options pricing allows firms to manage post-IPO compensation levels.

At the moment, accounting rules do not require companies to show the impact that stock options have on their earnings; they need only cite the information in footnotes in their annual reports. Companies currently have two choices in accounting for employee stock options: The Accounting Standards Board's Opinion No. 25 (APB 25) generally provides for the non-recognition of expense for grants of stock options with fixed terms. Whenever APB 25 accounting is not allowed, the Financial Accounting Standards Board's Statement 123 (FASB 123) requires expense recognition for the fair market value of the option on the grant date, spread over the vesting period.

Despite the FASB's push to have firms follow FASB 123, most companies have continued to follow APB 25 because it doesn't require them to expense employee stock options, says Steve Rimmer of PricewaterhouseCoopers. Cash-strapped technology concerns have been especially resistant to adopting FASB 123 because they have relied heavily on options as an incentive to attract and retain top talent. If they had been required to...

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