SEC views on valuing employee stock options
Sep 10, 2005
US FASB Statement 123R, like IFRS 2, requires that share-based payments to employees be measured by estimating the grant-date fair value of the equity instruments (such as options) that an entity is obligated to issue when employees have earned the right to benefit from the instruments (that is, when the right to the option has vested).
The main conclusion of our analysis to date is that instruments that track the future flows of net obligations facing the company or net receipts by its employees under the option grant can yield reasonable estimates of fair value as defined in Statement 123R. Further, our analysis indicates that instruments that replicate the terms and conditions of employee stock options or other share-based compensation do not produce reasonable estimates of fair value.
Replicating all of the terms and conditions of employee stock options with a market instrument is difficult. I also recognize that there may be alternative ways to provide an adequate estimate of the fair value of an employee stock option. As noted in the memo from OEA, there already are several methods that have been considered. Broadly speaking, my staff and I, with help from OEA, have become comfortable that it should be possible to design instruments whose transaction prices would be a reasonable estimate of the fair value of underlying employee stock options using either of the methodologies that seek to track returns to holders of options or the obligations of the issuer of those options. Further, while I recognize alternative views and new facts are possible, at this point, we have significant doubts based on OEA's views, as to whether it would be possible to design an instrument that would achieve the measurement objective of Statement 123R by relying on similar contractual terms and conditions. That is primarily because of the difficulties inherent in replicating the employer-employee relationship in an issuer-investor arrangement.