FASB Alters Volatility Valuation Rules for Private Companies

October 20, 2004 (PLANSPONSOR.com) - The Financial Accounting Standards Board (FASB) has decided to offer private companies some flexibility in the way they value stock options.

The easing of rules for valuing stock compensation awards for private companies is aimed partially at arriving at appropriate figures regarding ‘expected volatility’. Traditionally hard to measure for private companies, expected volatility is essential to calculating share value (see  Expensing Proposition ). As a stand in for fair valuation, FASB will now allow private companies to use an alternative method that calculates share volatility by applying historical volatility of an appropriate index as an input to the valuation model.

Companies would be allowed to use this caveat to the pending rules if a lack of predictability makes a reasonable estimate of fair value impossible. If a company meets this requirement, it will be allowed to us the calculated value model, which is expected to cut the cost and complexity of stock option valuations.  FASB members said that the move is expected to bring share valuations somewhere in between fair and minimum value. Volatility will most likely be undervalued, however.

Current rules allow private companies to assume a volatility of zero in calculating share value.

The forthcoming rules are to be applied by private companies for all stock compensation awards granted, modified, or settled beginning after December 15 of next year.

The new rules will go into effect for public companies on June 15 following a wide scale and successful push to have the deadline moved back six months in order for companies to have more time in which to comply with the new rules (see  Pressure on FASB Produces Options Expensing Delay ). The push by FASB to create stricter stock options expensing rules follows on the heels of the tech boom and subsequent bust, as well as accounting scandals like Enron and WorldCom, that have rocked Wall Street since then.