Six Companies Take Option Expensing For a Test Drive

September 26, 2003 ( - Still struggling with how to best value employee stock options, the Financial Accounting Standards Board (FASB) has organized a coalition of public companies for an expensing "road test."

Six companies that sit on the 33-member standards advisory council agreed to participate in the program that will assess the potential costs and benefits from expensing stock options.   Enlisting the council’s help, which acts as a sounding board for FASB to aid it in understanding what different constituents are thinking about accounting issues, the rulemaking body hopes to gain a broader perspective on the upcoming stock option expensing mandate, according to a Dow Jones report.

Scheduled to be test driven by the sextet is the Binomial option-pricing model, which tends to be a bit more sophisticated than its more widely used cousin the Black-Scholes method, based on its inclusion of more pricing variables than Black-Scholes’ five.     However, Black-Scholes has often been criticized for overvaluing stock options due to assumptions that both the option and the stock trade in liquid markets and that the risk-free interest rate and the stock’s price volatility remain constant during the option’s life.  This premise tends to not hold true with the long durations typical of stock options (See  Black-Scholes Overvalues Stock Options ).

Thus, it is within the Binomial model that the group hopes to find salvation since it is capable of incorporating more complex, non-traditional features, such as, indexed and performance-vested options.    Ultimately, FASB hopes the test run will better assess how much effort companies would have to put in when using the Binomial model versus the Black-Scholes model and how costly those efforts would be.

Committee Membership

“Since we have experience with both binomial and Black-Scholes, we are willing to help,” said Donald Humphreys, vice president and comptroller of Exxon Mobil, which switched to restricted stock from stock options last year as a form of compensation and is slated to be joined by Coca-Cola Co., CVS Corp., Yahoo Inc,   Siebel Systems Inc., and Lockheed Martin Corp. in the test run.

At least one member of the test pilot corps raises some eyebrows – Siebel.   However, even though the software maker opposes the movement toward counting employee options as an expense, its Chief Financial Officer Kenneth Goldman said, “it’s important to understand the implications from and the difficulties in expensing stock options.”

This comes in response to FASB’s April decision that companies should deduct the costs of stock options from earnings, rather than just disclosing the figures in footnotes to their financial statements   (See  FASB Says Yes to Option Expensing ).   Even though the Norwalk, Connecticut-based organization originally targeted the formalized rules to be in place by the end of 2003, a reprieve of sorts was handed down earlier this month when FASB announced it does not expect to issue a proposed rule until the fourth quarter of 2004.