If the company gives away shares at a discount (through options) and that discount is greater than the reported earnings then the company has actually made a loss. It is not accounted for by dilution.
efficient market theory should lower the price of the stock to account for the "discount". In this scenario, the "discounted" options would probably end up being out of the money. Thus, the options would end up not being sold (because they are out of the money and worthless). Once the options are bought out (this only happens when the options are in the money), there is a dilution which reduces earnings per share. If the market doesn't price the shares reasonably then options will be bought, converted to stock, and the stock will then be sold at inflated prices. The shareholders are not getting hosed by the options grant. They are getting hosed because they rallied the stock price too high. In other words, they overpaid.
The way the options can be fairly priced is to ask, "for how much money would the company be able to sell the options over the counter?" You see, the options only have that much value to the company. Just as if they had sold any other product. The value to the company, of any goods (in this case the options are the goods) or services, is what the market will bear. So, if instead of giving the options to employees the company were to sell them to the public, then it would be easy to determine their value. And then, we would know exactly how much money to expense.
That is why I have stated their value can be approximated by Black-Scholes type calculations just as LEAPS are valued. |
