| Members Area |
|
|
|
|
|
|
|
| Home Page | Reference Desk | ESOPs | Stock Options | Ownership Culture | About Us & How to Join | Order Form |
| |||||||||
| |||||||||
|
Home > Stock Options > Books >
March 2003. 158 pp. (6" x 9"), softcover. $25 for NCEO members; $35 for nonmembers.
The controversy about expensing stock options has generated front-page stories, fervent lobbying, and serious reconsideration of the role of stock options as a compensation tool. Given that assumption, what can companies do to restructure not just their option plans but their approach to equity compensation in general? This book gathers together the thinking of a number of nationally recognized experts in equity compensation to look at alternative strategies in a post-expensing world. It serves as a resource for companies as they consider how plans should be rethought in a post-expensing era.
Preface
Introduction
1. Alternative Models of Employee Ownership
2. How to Value an Employee Stock Option
3. Does the Black-Scholes Model Predict the Value of
Employee Options?
4. Life with Stock Option Accounting Plan Design Alternatives
5. Replacing Stock Options with Performance Shares
6. Global Equity Plans in a Post-Expensing Age
7. Plan Design in a FAS 123 Environment: A Design Roadmap
8. Restricted Stock Plans
9. Would Expensing Really Affect Stock Prices?
After mapping the tree of possible outcomes, the binomial model does a brute force calculation. It determines the value of the future gain at each node along the tree, for several consecutive branches or intervals. Then it weights each outcome according to its probability and discounts the whole tree to present value. The model’s magic lies in the estimates of the likelihood and magnitude of each up or down movement. While the up/down probabilities can be spoon-fed, the more typical way is to derive them from volatility. The other assumption required is the number of intervals in the tree.
An interesting fact about the binomial model is that as we increase the number of intervals, the model converges toward the Black-Scholes model. In fact, it does not take very many node intervals to get estimates that are very close between the two models. This is not by coincidence, as the models do not conflict. The authors of the binomial were not trying to get around or go beyond Black-Scholes so much as "come at it from a different angle."
In practical terms, the binomial model often gives little advantage over Black-Scholes, as the price outputs converge. However, as earlier mentioned, the binomial model’s design allows for the pricing of American options (i.e., options that can be exercised before the end of the term). For non-dividend-paying stocks, this advantage is not consequential. However, for dividend-paying stocks, an early exercise gets the option holder into dividends sooner rather than later. This makes the early exercise feature valuable. For this reason, when pricing an American-style option with a high dividend yield (e.g., an option on a REIT stock), it is in theory more accurate to use a binomial model or a special variation of the Black-Scholes model . However, as a practical matter, it may not be worth the trouble.
Performance shares may be defined as grants of actual shares of stock or stock units whose payment is contingent on performance as measured against pre-determined objectives over a multi-year period of time (the "cycle"); the value ultimately delivered to the participant is a function of performance against objectives and stock price performance during the cycle.
The key design features include (1) the term of the cycle and (2) using shares or share units. The term of the cycle is typically three to five years. We usually recommend three years in volatile businesses like high-technology industries. This recognizes the start-up nature of the plan (and long-term goal-setting process) at most businesses. It recognizes the short-term nature of planning horizon in high-technology businesses.
As for shares or versus share units, we usually recommend share units. They permit the ultimate design flexibility. Firms can choose to not credit dividends, or to credit dividends and pay currently, or to credit dividends and accumulate for payout with (and in proportion to) the earn-out of share units. Using share units also permits the extension of the relationship and restrictions beyond the termination of employment (which would not be permissible with actual shares under Internal Revenue Code Section 83); this may be desirable to enforce non-compete provisions or facilitate installment payouts after "friendly" terminations. Actual shares would require certificates to be issued (usually held by treasury), and dividends to be paid currently or accumulated during the cycle.
Copyright © 2002 by The National Center for Employee Ownership (NCEO) (phone 510/208-1300; email nceo@nceo.org; WWW http://www.nceo.org/). All rights reserved.
| Home | Reference | ESOPs | Options | Culture | About Us | Order Form |