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To: Windsock who wrote (173098)	2/17/2003 11:28:41 PM
From: tcmay	Respond to of 186894

"First consider the case for a company that has an employee who leaves and surrenders the 4 or 5 years worth of options in the pipeline. Does the company now get to declare "earnings" for the value of the returned options? This could really distort earnings particularly for older options if the stock has risen in value considerably." An analogous situation happens frequently with options in general (traded options, that is). Suppose I sell someone a covered call. They pay me some amount of money. I report this money as income. If the option expires unexercised, which is analogous to an underwater option being unexercised, no further income is reported. For someone who _leaves_, when the option is above water, there might be some tweaking of the imputed earnings that would be good to do. (I didn't claim the whole plan could be written down on a 3 x 5 card, just that the general principle is that giving someone a thing of value is income for them and an expense for the giver.) "Now consider the employee. What happens when (s)he leaves the company company? Are the tax payments for the options returned or do you treat the option surrender as a "capital loss" that can only be offset for the most part against a capital gain? The same problem arises for vested options that are underwater and expire or are abandoned when the employee leaves." The underwater options are as I described above: just like options which have expired worthless. If Alice pays Bob for some job by giving him an option she bought for $1000, then Bob has most certainly received $1000 in pay. If that option expires worthless, he lists the option price (which he has already paid taxes on, and the zero value, and hence generate a loss just as with an ordinary option that expires worthless. And if makes more money, the option itself has had a capital appreciation, just as options are treated today. "Stock options that are traded on the open market have accurate market-value pricing and answers for these questions but employee stock options have some very large issues. " There are ways to get pricing information on longterm options. One way is to do shadow sales, selling some fraction of the same options, with roughly similar conditions, on the open market. (I don't want to write for the next hour, so I can't explore all of the problems and issues.) Another way is to give employees with options the chance to take a pay package instead of the option. This crudely establishes a market clearing price. Now, of course, a problem is that Bob Employee may be planning to leave the company before his options vest, so he will, in some sense, be happy with nearly any pay package in lieu of stock. Still, the point is that pricing estimates can be made. A company could literally contract with an option-writing company to provide the stock options. If the option company evaluates an employee, judges the likelihood that he will last long enough to collect (a variant of the actuarial problem in insurance), looks at existing 2- year LEAPs, and says "We will provide this option for this class of employee for $1.87 a share," for the price, conditions, etc., then this is an indication of "the market value." Companies could request three bids and choose the least expensive. The point is that price discovery happens in many situations. The notion that no one can possibly know the worth at the time of grant of a stock option is unsupportable. --Tim May

To: Windsock who wrote (173098)	2/18/2003 5:35:38 AM
From: rkral	Respond to of 186894

OT ... Windsock, re "First consider the case for a company that has an employee who leaves and surrenders the 4 or 5 years worth of options in the pipeline. Does the company now get to declare "earnings" for the value of the returned options?" "in the pipeline"? You could be referring to non-vested options, or vested options that are underwater, or both. I'm not familiar with an options definition for "in the pipeline". <g> If and when the SFAS 123 fair value method is implemented -- re non-vested options - Options need not be expensed before vesting. If options are expensed before vesting and these options are cancelled, the expenses previously recognized are "recovered". In practice, this merely means options expense is reduced in the period when cancellation occurred. Cancellation includes employee departures. re vested underwater options - There is no expense recovery, whether the employee departs, or whether the options expire worthless. Just the opinion of an engineer, not an accountant. Ron