FASB Considers New Model to Replace Black-Scholes for Pricing Employee Stock Options

September 15, 2004 (PLANSPONSOR.com) - The Financial Accounting Standards Board (FASB) will consider a new model to value employee stock options.

Following its announcement that it would require US companies to expense employee stock options starting next year, uproar grew surrounding the correct way to expense the options. The traditional method used, the Black-Scholes model, does not take into account the fact that employee stock options are nontransferable and cannot be hedged, thus not giving a realistic value, critics said.  

A model first proposed to replace the Black-Scholes model, named ‘Lattice’, was widely criticized as too complex and too expensive for small companies.

In response, a new model, created by Cisco Systems Inc., Qualcomm Inc, and Genentech Inc., with the help of accounting experts, was prepared for FASB, according to Reuters. Supporters of the new model state that it would be easy to use and would correctly price employee stock options. It would reduce the value of stock options by up to 70%.

“There is enough research that shows that nontransferability significantly impacts the value of employee stock options,” said Kim Boylan, attorney with Latham & Watkins, who acted as a consultant to Cisco and to the International Employee Stock Options Coalition, according to Reuters.