ESOs: Conclusion
AAA
  1. ESOs: Introduction
  2. ESOs: Accounting For Employee Stock Options
  3. ESOs: Using the Black-Scholes Model
  4. ESOs: Using the Binomial Model
  5. ESOs: Dilution - Part 1
  6. ESOs: Dilution - Part 2
  7. ESOs: Conclusion

ESOs: Conclusion

By David Harper

Most public companies grant stock options (ESOs) to their employees, and almost everybody agrees that ESOs represent a cost to shareholders, or, to put it differently, that ESOs dilute the ownership of current shareholders. Because of this cost, accounting rules will probably require companies to expense ESOs in order to increase the accuracy of reported profits. There is, however, little consensus on how to calculate the cost of ESOs. As we have throughout this tutorial, any estimate will be imprecise because capturing the full cost of ESOs always requires making assumptions about unknown future events, such as the movement of the stock price, employee turnover and employee exercise behavior.

Because of these assumptions, it is beneficial for investors to understand how accounting rules treat ESOs, and how to improve the accounting numbers to get a clearer picture of the economic impact of ESOs on the valuation of the company. Here is a summary of the perspectives on ESOs that this tutorial covers:

  • Diluted EPS is a good start, but it will always underestimate the true cost of ESOs because it omits the time value of all options and therefore does not incorporate out-of-the-money ESOs.
  • For accounting purposes, the Black Scholes Model is currently the most popular options-pricing model, but it was designed for options that trade on an exchange and will therefore probably be replaced by the more versatile binomial model.
  • For valuation purposes, economic overhang - an improvement over the popular equity overhang - is a good way for investors to assess the dilution impact of ESOs. Finally, the cash-flow method is probably the best, if you have the time to compute it.

  1. ESOs: Introduction
  2. ESOs: Accounting For Employee Stock Options
  3. ESOs: Using the Black-Scholes Model
  4. ESOs: Using the Binomial Model
  5. ESOs: Dilution - Part 1
  6. ESOs: Dilution - Part 2
  7. ESOs: Conclusion
RELATED TERMS
  1. Back Pay

    The amount of salary and other benefits that an employee claims ...
  2. Contingent Commission

    A commission with a value dependent on an event occurring, and ...
  3. Collection Commission

    The percentage of premiums that an agent is owed for collecting ...
  4. Accident Year Experience

    Premiums earned and losses incurred during a specific period ...
  5. Book Value Reduction

    Reducing the value at which an asset is carried on the books ...
  6. Cash Bonus

    A lump sum of money awarded to an employee, either occasionally ...
  1. How are accounts payable listed on a company's balance sheet?

    Find out how accounts payable is listed on a company's balance sheet, why it is considered a current liability, and how it ...
  2. Why do businesses calculate accrued expenses?

    Find out why businesses calculate accrued expenses, how they are applied and what circumstances give rise to accrual entries ...
  3. Are accounts payable an expense?

    Learn about how to differentiate between liability accounts and expense accounts, and see why accounts payable is considered ...
  4. Are accounts payable an asset?

    Find out why the general ledger accounts payable is considered to be a current liability, not a current asset, and how it ...

You May Also Like

Related Tutorials
  1. Options & Futures

    Binary Options Tutorial

  2. Mutual Funds & ETFs

    Top ETFs And What They Track: A Tutorial

  3. Active Trading Fundamentals

    Introduction to Stock Trader Types

  4. Options & Futures

    Options Pricing

  5. Options & Futures

    How To Place A Covered Call Strategy With optionsXpress

Trading Center