ESOs: Conclusion
  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. Employee Stock Option - ESO

    A stock option granted to specified employees of a company. ESOs ...
  2. Cashless Exercise

    A transaction that is used when exercising employee stock options ...
  3. Overhang

    A measure of the potential dilution to which a common stock's ...
  4. Diluted Normalized Earnings Per Share

    A company's profit less one-time earnings, divided by both outstanding ...
  5. Cost Accounting

    A type of accounting process that aims to capture a company's ...
  6. Option Schedule

    A list of options grants to an employee or employees of a company ...
RELATED FAQS
  1. What are the main advantages and disadvantages to the cost accounting method?

    Read a brief overview of the main advantages and disadvantages of the cost accounting method as it relates to business analysis ... Read Answer >>
  2. What is the average return on equity for a company in the electronics sector?

    Learn about the Black-Scholes option pricing model and the binomial options model, and understand the advantages of the binomial ... Read Answer >>
  3. What does it signify about a company if there is a large difference between its EPS ...

    Learn more about basic earnings per share and diluted earnings per share, what the ratios measure and what a large discrepancy ... Read Answer >>
  4. Why should investors consider the fully diluted share amount?

    Learn about the importance of considering the fully diluted shares, how it could affect a stock's share price and how dilution ... Read Answer >>
  5. How do you calculate diluted EPS using Excel?

    Learn what diluted EPS is, the common formula used to calculate it and how to calculate diluted EPS on Microsoft Excel, using ... Read Answer >>
  6. What's the difference between basic shares and fully diluted shares?

    Find out more about basic outstanding shares, fully diluted shares, the difference between the calculation of shares and ... Read Answer >>
Hot Definitions
  1. Demand Curve

    The demand curve is a graphical representation of the relationship between the price of a good or service and the quantity ...
  2. Goldilocks Economy

    An economy that is not so hot that it causes inflation, and not so cold that it causes a recession. This term is used to ...
  3. White Squire

    Very similar to a "white knight", but instead of purchasing a majority interest, the squire purchases a lesser interest in ...
  4. MACD Technical Indicator

    Moving Average Convergence Divergence (or MACD) is a trend-following momentum indicator that shows the relationship between ...
  5. Over-The-Counter - OTC

    Over-The-Counter (or OTC) is a security traded in some context other than on a formal exchange such as the NYSE, TSX, AMEX, ...
  6. Quarter - Q1, Q2, Q3, Q4

    A three-month period on a financial calendar that acts as a basis for the reporting of earnings and the paying of dividends.
Trading Center