Expensing Executive Stock Options : Sorting Out the Issues

This paper examines the issues and controversies over the question of whether executive stock options should be expensed and, if so, how option values should be determined. It identifies and clarifies the key questions and surveys and synthesizes the academic and trade literature. Illustrations and analyses of valuation models are provided. The paper identifies several key issues that have received little attention, such as whether the value to the executive is the cost to the company, how the effects of vesting and forfeiture should be incorporated while maintaining consistency with sound valuation theory, and whether these options should be marked to market. The paper also identifies two areas that have received almost no attention in either the practitioner or academic literature. One is the effect of taxes on the values of these options. The other is the impact, if any, of the influence an executive presumably has on the payoff of the option on the executive's willingness to hold an undiversified portfolio and what effect this factor has on the value of the option