Page 164 - Bruce Ellig - The Complete Guide to Executive Compensation (2007)

150 The Complete Guide to Executive Compensation

would be willing to buy their options at a price somewhere around 30 percent of the option
price? The one problem with such present-value models for a long period of time is that the
value will be something other than the calculated value. It could be significantly greater,
significantly less, or somewhere in between. Additionally, executives do not accept the logic
that a higher-priced option is worth more than a lower option price. This is generally true
when the higher-priced grant preceded the lower-priced grant. For example, the executive
received a grant at $75 a share and, one year later, an additional grant at $60 (because the com-
pany’s stock price dropped). Present-value calculations might have put these at $25 and $20,
respectively. Even if the executive agreed with the $20 for the $60 option, the person would not
see the logic to an option priced $15 higher ($75 $60) to be worth an added $5 ($25 $20).
In mid-1993, FASB issued an exposure draft that would require an earnings charge for
all grants. In 1995, after a decade of deliberation, FASB issued FAS No. 123. It stated com-
panies had a choice. Either continue using APB 25 as before, or determine cost at time of
award with a present-value formula such as Black-Scholes. However, the company must use
the same method for all employee stock plans. And if they used APB 25, they had to show
the present-value impact in the financial footnotes as if FAS 123 were used. Since stock
options issued at fair market value have no discount, the cost under APB 25 is zero. Not
surprisingly, for many years few companies used FAS 123. A comparison of key points of
APB 25 and FAS 123 is shown in Table 4-29.

Definition APB 25 FAS 123
Measurement date When number of shares and Grant date
price per share first known
Measurement cost Market value less cost to Present value
buy on measurement date
Expense report Charged to income Charged to income
statement if an expense statement as an expense
or as a footnote
Expense period Until vested Until vested

Table 4-29. Comparison of APB 25 and FAS 123
In 2000, FASB issued Interpretation No. 44. The stated intent was to further interpret,
not amend or modify APB 25. It permitted the inclusion of non-employee directors and some
leased employees. And it described when stock option repricings, reload options, and stock-
for-tax withholding result in an earnings charge because of a new measurement date.
In late 2004, FASB issued FAS 123R, “Statement of Financial Accounting Standards:
Share-Based Payment,” replacing the original FAS 123 and repealing APB 25. The new
standard requires all equity awards be subject to fair-value accounting. It is equal to stock
value for full-value awards (e.g., performance shares and restricted stock) and estimated using
an option pricing model for appreciation-value awards (e.g., stock appreciation rights and
stock options). But the standards did not mandate a particular option pricing model; it indi-
cated that the Black-Scholes, lattice, and Monte Carlo simulation models were all acceptable
alternatives. This flexibility raised a question as to the extent it was a standard vs. a guideline
since it would be difficult to compare the resulting values of any two companies.