CEO Group Hits FASB for More Options Expensing Testing

The Business Roundtable letter from President John Castellani complained to the Financial Accounting Standards Board (FASB) that both the Black-Scholes and binomial valuation methods offered under the proposal result in inaccurate valuations.

The Business Roundtable’s members have a variety of opinions on mandatory expensing and the letter did not take a position, though the group agreed that the method of estimating the value of options must be fair and reasonable, reflect real economic values and costs, and be reasonably comparable across various industry sectors, Castellani wrote in the  letter .

“We do not believe that FASB has demonstrated that the ‘fair value’ models it has proposed meet these criteria, and we have serious concerns that, in fact, they do not meet this standard,” the letter stated.

The group said there was no evidence that the proposed valuation models will meet FASB’s definition of establishing “fair value” for the options, which would be the price investors would be willing to pay for an equity instrument with similar characteristics. Because the proposed models don’t effectively recognize the special characteristics of the options, such as nontransferability, nonhedgibility, and blackout periods until vesting, they substantially overstate the options’ value (See  Coalition Calls For Option Expensing ‘Field Test’  ).

Castellani’s group asserted that the accounting rulemaker should instead conduct a market test of the various valuation models. The group suggested that FASB conduct a market test of the valuation models. “If the test determines, as we believe it will, that market participants would not be willing to pay a price for such call options equal or close to the grant value estimated by the model, then the FASB must modify the model to meet its ‘fair value’ definition and defer the proposed requirements for mandatory expensing until it has done so,” Castellani wrote.

U.S. Representative Richard Baker (R-Louisiana) and other options expensing naysayers have made the inaccuracy of the valuation models the centerpiece of their argument. The House Financial Services Committee June 15 approved Baker’s measure (H.R. 3574) to prevent the U.S. Securities and Exchange Commission from accepting the FASB proposal and instead limit mandatory expensing to a company’s top five executives (See FASB Options Expensing Limit Bill Gets Committee OK ).

Currently, companies are only required to disclose the cost of stock options as footnotes to the financial statements.   Some investor groups have argued the current method of accounting for stock options makes it difficult to gauge the effect stock options have on a company’s bottom line.   It was “i n response to requests from investors and many other parties to improve the current accounting standards relating to employee stock compensation in financial statements” that FASB said its proposal was issued.  

Business Roundtable is an association of chief executive officers of corporations with a combined workforce of more than 10 million employees in the United States and $4 trillion in revenues.