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Technology Stocks : Cisco Systems, Inc. (CSCO)
CSCO 73.42-2.4%Jan 20 3:59 PM EST
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To: GVTucker who wrote (64059)5/15/2003 1:45:31 PM
From: bofp  Read Replies (2) of 77400
 
Black-Scholes was formulated to value options at the time of issuance. Until someone else wins a Nobel Prize by identifying a better methodology, B-S is the last word on that topic.

However, we are not trying to value options at the time of issuance. Employees come and go and many issued options do not vest. Current proponents of expensing options are advocating using Black-Scholes to value previously issued options at the time of vesting. This is akin to using a socket wrench to hammer nails. Essentially, this bastardized technique involves establishing the value of the option at the time of issue, but expensing it at the time of vesting. However, if the underlying value of the security and its volitility changes dramatically between issue and vest, the valuation of the option can become misleading, often comically so. This is why the B-S based methodology suggests that Cisco options vested in 2002 with a $40 strike price had significant value, even though common sense should tell anyone that the likelihood of those options expiring worthless was very high indeed.

One solution would be to expense options as issued, adjusted for a predicted likelihood of vesting, but this has some issues vis a vis the matching principle. Frankly, I believe the best solution is to force companies to issue restricted stock grants rather than options. Stock grants are easily valued and transparent to shareholders. This has the exact same "benefit" claimed by Chambers - giving employees ownership - without the opaque accounting treatment. Call me cynical, but I think the main benefit to Cisco management is actually the opaque accounting treatment.
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