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