Employee Stock Options - NQSOs & ISOs Message Board

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Strategies & Market Trends : Employee Stock Options - NQSOs & ISOs

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To: rkral who started this subject	7/31/2004 5:15:19 PM
From: Don Lloyd	Read Replies (1) of 786

FWIW - empower.org (31 pages full version WORD file) empower.org (9 pages condensed version WORD file) "...The fact that ESOs may be a cost to the issuing company’s shareholders has never been in dispute. Accountants have long recognized that an ESO is a contingent claim on the net income, net assets and market value of the company that grants it, and as such, represents a potential cost to the grantors’ shareholders in the form of dilution. That is, if the stock underlying the employee option rises and the option is subsequently exercised, shareholder ownership will be diluted, resulting in a transfer of value from shareholders to employees..." "...The third and perhaps most important count on which the above argument fails is that it neglects to consider the fact that an actual “cost” of an ESO cannot be incurred unless there is an increase in the value of the enterprise in an amount substantially greater than the cost. This may be illustrated with the following analogy: Assume a company is a plaintiff in a $100 million lawsuit it has a 75% chance of winning. The expected value of an eventual award, therefore, is $75 million (not including a discount for the time value of the money). The company’s legal counsel has the case on contingency for 30% of the final award. This means that the expected value of the company’s cost to prosecute this lawsuit is 30% of $75 million, or $22.5 million. Under the logic of FASB’s proposed expensing rules the company would record an expense of $22.5 million (less a discount for the time value) amortized over the period expected to adjudicate the lawsuit. But it would not record the $75 million expected value of the award. Just as the legal cost of this lawsuit is wholly dependent upon the winning of the award, so is the call premium wholly dependent upon the appreciation of the shareholders’ ownership value. The point is, it would be illogical in the extreme to record the hypothetical cost of an ESO without also recording its more than offsetting hypothetical benefit." ---Kip Hagopian (see the full version) Regards, Don

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