Page 163 - Bruce Ellig - The Complete Guide to Executive Compensation (2007)
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Chapter 4. The Stakeholders                     149


           above fair market value (FMV) at grant date and vest solely on time. The other exception to
           the basic rule that came from this ruling is restricted stock. The value of the stock at time of
           grant is prorated over the vesting period, whereas other multiyear performance stock awards
           are accrued on the basis of period-ending value, since the stock price and/or the number of
           shares are not known at time of grant.
           Financial Accounting Standards Board. In 1973, the APB was replaced by the Financial
           Accounting Standards Board (FASB), an independent group financed by the private sector.
           It currently consists of seven members approved by the Financial Accounting Foundation.
           The view of some was that industry was so upset with a number of APB Opinions (especially
           APB 25) that they financed the establishment of a new accounting authority. However, it, like
           its predecessors, remained subject to SEC control. Namely, if the SEC did not concur with
           FASB’s actions, it could reverse them. And in turn, the chair of the SEC could be overruled
           by the Secretary of the Treasury, the U.S. president, or by congressional action.
               About 10 years after formation, certified public accountants requested a reexamination
           of stock plans by FASB. The major issue was stock options. Virtually everyone agreed
           they were a part of compensation, but under the measurement date principle, there was no
           recognized expense.
               FASB undertook the review of accounting for stock because it believed that plans with
           similar economic benefits to employees had different accounting treatment. Moreover, not
           only had a number of new plan types been developed since Opinion 25 in 1972, but new
           valuation methods for valuing stock options had also been developed.
               In the mid-1980s, FASB tentatively decided to adopt a minimum value method to deter-
           mine the accounting cost of employee stock options. The calculation would be the stock’s fair
           market value at time of grant minus the present value of the option price using a risk-free rate
           of return discounted from the option’s maximum term (10 years in most cases). The net
           amount would then be reduced by the present value of the expected dividends during the
           same maximum term, also discounted by the same risk-free rate of return. Some argued this
           was mislabeled, as it was more like a maximum value. Based on a flurry of objections to this
           approach, FASB explored various adjustments to the model (e.g., date of vesting instead of
           date of grant).
               In 1986, FASB ruled that dividends on restricted stock should be recognized as a
           compensation expense rather than charged to equity like other dividends.
               While FASB was still deliberating on the method for costing stock options, the SEC
           stated in late 1992 that the stock option/stock appreciation right (SAR) grant table in the
           proxy statement could use assumed 5 percent and 10 percent appreciations or a present-value
           method such as the Black-Scholes Formula.
               The formula developed by Fisher Black and Myron Scholes was not the first attempt to
           measure financial risk—efforts can be traced back to the beginning of the century. However,
           their formula is the most widely acclaimed for helping investors put a price tag on risk. This
           mathematical formula published in 1973 was created to value stock options traded on public
           markets. It looks at a grant date, number of years option is exercisable, the option price, the
           stock price, volatility, dividend yield, and risk-free interest rate. The formula is further
           discussed in Chapter 8 (“Long-Term Incentives”). Based on these values, it estimates the fair
           value one should pay for an option. However, not everyone agrees with such present-value
           calculations for executive stock options. Unlike stocks on the market, executive stock options
           are not bought and sold, nor is the time period measured in months. How many executives
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