ESOs: Introduction

by David Harper

In this tutorial we review the accounting and valuation treatment of employee stock options (ESOs) and illustrate the best ways for investors to incorporate them into their analysis of stock. In the next section, we begin with a summary of the accounting treatment of ESOs, and then in the third and fourth sections we progress into a review of the primary options-pricing models: the Black-Scholes and its likely successor in 2005, the binomial model. In the fifth and sixth sections, we will consider adjustments you can make to incorporate the cost impact of stock options into your equity valuations.