Fasb backdating stock options
But accounting practices are rife with ambiguities.
As long as the rules are understood, accounting helps paint a picture of corporate value with a semblance of consistency.
Specifically, there are questions of integrity, manipulation, accounting issues, valuation issues, consistency, corporate hypocrisy when it comes to backdating and share buy-backs, and appropriate disclosure. For example, suppose an employee were given an option to buy 100,000 shares of the company; the shares vest in three years; and the shares have a strike price of .
Stock options give an employee the right to buy stock in the company at a future date at a set price and are a form of compensation.
The Black-Scholes model has deficiencies in valuing long-dated stock options, and I felt the FASB was right to recommend the Binomial model for valuing options.
The Binomial model was more flexible for doing scenario analyses on corporate earnings and assessing risk, but I was still concerned about the potential for corporate officers to manipulate the system.
regulators for backdating employee stock options, and many more will follow.
In three years, the option will be worth nothing if the option price is below , but if the price of the company stock rises to , the employee pockets a gain of 0,000, and the company deducts this amount.
One has to estimate the probability of a future gain and the timing of a future gain, and it makes sense to come up with a standard way of estimating today’s value.
Whichever model a corporation used, the biggest fudge factor in determining value is the volatility assumption. One proposal had surfaced suggesting that one could assume zero volatility.
Have you ever heard of a stock price that never moved?
At issue were options on derivatives, not employee stock options, but Freddie Mac’s problems suggested potential future manipulation of employee stock option reporting.
Freddie Mac’s officers arbitrarily decided that volatility calculated based on the then current market prices did not reflect fair value.