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Stock Based Compensation Plans Assignment Sample


1.1 Background

Employees and other parties are frequently given share options by companies. Not only for directors and top executives, but for many other employees as well, stock-based compensation programmes have become a standard component of employee compensation. To compensate suppliers, such as those who provide professional services, some businesses issue shares or share options. There is currently no International Financial Reporting Standard (IFRS) on how to account for stock-based payments, despite their growing use. This lack of a worldwide standard has drawn criticism. For instance, the International Accounting Standards Committee (IASC), the predecessor organisation of the International Accounting Standards Board (IASB), should take into account the accounting treatment of stock-based compensation, according to the International Organization of Securities Commission's (IOSCO) assessment of international standards (www.iosco.org).

Few nations have guidelines in this area. This is especially concerning in Europe, where the use of stock-based compensation has grown dramatically in recent years and is still expanding, but where there is no accounting guidance. Recently, the Financial Accounting Standards Board (FASB) in the United States and the IASB has started collaborating on this issue. As of now, everyone is in agreement that every stock-based payment transaction should be recorded in the financial statements, resulting in an expense in the income statement when the goods or services are used (www.iasc.org.uk).

In 1993, FASB made an attempt to implement an accounting standard that would force businesses to include stock options in their income statements and classify them as an operational expense. Companies vehemently disagreed with this suggested declaration (www.fei.org/advocacy/download/StockOptionAccounting-OnePager.pdf). Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation," (SFAS 123) was finally released by FASB in 1995 after much debate.

Companies are encouraged, but not required, to apply the same accounting method to stock-based payments to employees, and if that method is not applied, the standard requires disclosures of pro forma net income and earnings per share, as if the method had been applied (www.fasb.org). However, according to accounting assignment help, FASB is still dealing with the issue of how to treat stock-based payments with parties other than employees.

IASB proposed that the IFRS be effective for periods beginning on or after 1 January 2004 when it issued the Exposure Draft ED 2 "Share-Based Payment" on November 7, 2002. IASB invited comments on the proposals in the ED 2 by March 7, 2003. IASB will take into account the comments received on the Exposure Draft when finalizing the IFRS, which it plans to do by the end of 2003.

Although the topic of stock options raises a number of issues, which will be covered in the following section, even with the adoption of standards, the two standard-setting bodies are still working on standards controlling accounting for stock option programmes.

1.2 Problem

Initially praised for their ability to incentivize management, stock options are now blamed for encouraging management to take a variety of actions to increase company share prices and keep their option packages "in the money."2 It is now generally acknowledged that management was aided by accounting practices that did not require the cost of stock options to be treated as an expense (The Economist, November 2002, Vol. 365, Issue 8298).

When the Accounting Principles Board (APB) released Opinion No.25 (APB 25), "Accounting for Stock Issued to Employees," in 1972, it set forth the first rules for accounting for stock options. According to APB 25, options were measured at their intrinsic value, which was determined at the grant date. However, at a grant date, the market price and exercise price are typically the same, so the value of the stock options was then typically zero.

The standard-setting bodies FASB and IASB, as well as many economists, analysts, and investors, came to the unanimous conclusion that expensing stock options, i.e. deducting their costs from a company's profits, is the best course of action. In practice, however, companies tend to object to such treatment of stock options, arguing that it is unfair to employees and other stakeholders (Dakdduk, 1996).

Another concern raised with regard to stock options is how they are valued and when they should be expensed. Economists generally concur that stock options should be expensed using a fair-value method, which reflects what the options would cost to buy in the market if they were available. Both economists and IASB rule out two other methods, such as the intrinsic value and the minimum value method (The Economist, November 2002, Vol. 365, Issue 8298).

Three main questions can be derived from the debate above:

Should businesses deduct stock option costs?

• What should be the value of stock options?

• Is granting an option a one-time expense for businesses, or is it a contingent obligation, the full cost of which becomes apparent when options are exercised or expire, and whose potential cost varies with changes in the market price of businesses' shares?

We will further explore what issues raise the most controversy and what are the commonly provided answers when it comes to implementing the accounting for stock options in practise, and we will compare the answers provided by the standard-setting bodies, IASB and FASB in this thesis, and the companies.

1.3 Research Issue

Our thesis will provide a solution to the following question:

• How does the corporate community feel about depreciating stock-based compensation plans, and what are the arguments for and against?

1.4 Purpose

This thesis's four main goals are as follows:

• Describe both current and prospective regulations, specifically:

- Statement of Financial Accounting Standard No. 123's "Accounting for Stock-Based Compensation";

- Statement of Financial Accounting Standard No. 148, "Accounting for Stock-Based Compensation - Transition and Disclosure;"

- "Share-Based Payment," International Financial Reporting Standard Exposure Draft;

- "Accounting for Stock-Based Compensation: A Comparison of FASB Statement No. 123, Accounting for Stock-Based Compensation and Its Related Interpretations, and IASB Proposed IFRS Share-Based Payment," an invitation to comment.

• Contrast the current and planned stock option accounting regulations with how businesses actually account for stock options.

• Conduct an examination of a few different Comment Letters.
Submitted by various companies in order to determine the major topics they discussed and their opinions on how stock option programmes should be treated in financial statements.

• Outline your conclusions based on your analysis.

1.5 Delimitations

The primary existing and proposed rules regarding stock options have been chosen, but one of the proposed rules is an Exposure Draft and one is an Invitation to Comment, and the periods over which Comment Letters can be submitted on these Exposure Draft and Invitation to Comment are still open. As a result, the final version of the standards may differ from the proposed ones primarily due to time constraints.

We chose a number of Comment Letters submitted by companies with regard to the current and proposed FASB rules because it was not practical to study all submitted Comment Letters; for the IASB Exposure Draft "Share-based Payment," we will analyse the Comment Letters submitted on the Discussion Paper, which came before the Exposure Draft.

Due to the expensive expense of buying all of the available Comment Letters and the constrained time constraint, only a small subset of Comment Letters will be examined.

1.6 Thesis Outline

Chapter 2:

The research methodology, methods used to gather and evaluate the theoretical and empirical data, and evaluation of the research's quality are all covered in this chapter.

Chapter 3:

This chapter examines the idea of stock-based compensation, its impact on company performance, the current FASB and IASB rules and regulations governing employee stock-based compensation plans, whether or not a stock-based compensation plan results in a company expense, how to measure the expense and when to recognise it, and whether or not a stock-based compensation plan results in a company expense.

Chapter 4:

We review the Comment Letters submitted by various companies with regard to FASB and IASB issued standards and Exposure Draft regarding accounting for stock-based compensation plans and describe the ways in which a number of companies reflect the stock-based compensation expense in their financial statements in this chapter, which covers the empirical evidence we gathered during the course of our work.

Chapter 5:

We review the study's findings in chapter 5 and offer our thoughts.

Chapter 6:

Our study's findings and the resolution of our research question are presented in Chapter 6, where we also make recommendations for potential future studies.

2 Methodology

We explore numerous methodological techniques that can be employed when carrying out research activities in this chapter, as well as the methodologies we selected and their justifications.

2.1 Research Approach

Patel & Davidsson (1994) claim that research methodologies can have three features as mentioned below. The choice of research approach depends on the degree of accuracy with which the original research question can be formulated, and how much knowledge there is in the domain of the chosen subject.

The main goal of exploratory studies is to gather as much knowledge as possible about a study problem area, which entails that the problem is analysed from a variety of points of view. A wealth of ideas and creativity are important elements in explorative studies because these frequently aim at obtaining knowledge that can lay the groundwork for further studies (Patel & Davidson, 1994).

In a descriptive study, just the crucial features of the phenomena are examined; the descriptions of these aspects are in-depth and fundamental, and the descriptive technique is best suited to inquiries where there is already knowledge (Patel & Davidson, 1994).

When there is enough data to create new theories, the hypothesis testing approach is utilised. The researcher gathers data and formulates hypotheses that will be tested in the real world and will either be accepted or rejected (Patel & Davidson, 1994).

We read several articles and other sources related to stock-based compensation plans and accounting for them, as well as analysed some chosen Comment Letters, which present the viewpoint of the business community on the topic of accounting for stock-based compensation. This data collection provided the foundation for both the exploratory and descriptive approaches that were used in our thesis.

2.2 Research Perspective

The positivistic approach and the hermeneutic approach are the two main viewpoints that can be used in scientific inquiry (Patel & Davidson, 1994).

The positivistic approach is based to a large extent on measurement of, and logical reasoning about, reality. It is based on experiments, quantitative measurements, and logical reasoning. It is based on scientific rationality. It should be possible to empirically test the knowledge in order for it to be meaningful (Patel & Davidsson, 1994).

Under the hermeneutic approach, the researcher tries to see the big picture in a research problem. Hermeneutics is about interpreting the meaning in texts, symbols, and experiences. The hermeneutic approach uses the researcher's own knowledge, thoughts, impressions, and feelings in order to understand the study object. These attributes are an asset for the researcher and not an obstacle (Patel & Davidsson, 1994).

Our research was based on our interpretations of the phenomenon we are studying, and it is more biassed toward the hermeneutic approach in our thesis. We looked at the IASB and FASB regulations relating to stock option plans, as well as whether or not companies expense stock options in their financial statements and comment letters, which gave us an overview of the companies' perspectives on the treatment of stock option plans.

2.3 Research Design

The inductive approach is the formulation of general theories from specific observations, as opposed to the deductive approach, which is the derivation of a new logical truth from existing facts (Melville & Goddard, 1996). The deductive approach can be defined as when a theory concerning the chosen subject already exists and a hypothesis is formed from it.

The inductive and deductive procedures are combined in the abduction methodology, and from this the researcher develops an analysis of the empirical data and prior hypotheses (Alvesson & Sköldberg, 1994).

We started by gathering information and trying to condense it into a brief summary format, furthermore, we established a link between the objectives of our research and the findings we derived from the collected data. On the other hand, we can say we tested the existing theory as we tried to look into the ongoing movement. In our opinion, our thesis is a combination of both the deductive and the inductive approaches.

2.4 Research Method

The most significant distinction between these methods is that the quantitative method converts the information obtained into numbers, and from these data, a statistical analysis is carried out. Research can be undertaken using quantitative or qualitative methods, or a combination of both (Holme & Solvang, 1997).

The main goal of qualitative research is to obtain a more profound understanding than the fragmented information generated by quantitative methods; in a qualitative approach, it is the researcher's understanding or interpretation of the information that is vital. Qualitative data is often appropriate for research projects that aim to understand or describe something in more detail (Holme & Solvang, 1997).

The data that are acquired, analysed, and evaluated in our study cannot be properly described in figures because we want to get a deeper understanding of the study object and do not strive to validate the validity of our results using quantitative methods or statistical tools.

2.5 Data Collection

For the research to be relevant and the solution to the problems to be applicable, data collection is of utmost importance.

Different types of data, including primary and secondary data. Primary data is information collected and used for the first time, typically through direct examination, whereas secondary data consists of information already available, i.e. it has been collected or produced by a third party and perhaps for a different purpose (Eriksson & Wiedersheim-Paul, 1999). (Lekvall & Wahlbin, 1993)

The materials we studied for our analysis, which is based on secondary data, included books, papers, annual reports, Comment Letters, and data from the websites of the FASB, IASB, and other organisations.

It is crucial for the reader to comprehend the IASB and FASB rule-making procedure (called Due Process) and the function the Comment Letters play in that process since our study incorporates an analysis of Comment Letters.

The FASB and IASB systems of due process give interested parties the chance to voice their opinions on the proposed accounting rules, with the goal of carefully weighing those opinions to ensure that the standards meet the needs of the constituents. The first step in the due process is choosing the issue on the agenda, followed by the release of a Discussion Memorandum/Paper, an Exposure Draft, and then an accounting standard.

On the Exposure Draft to SFAS 123, there were more than 700 Comment Letters submitted (www.fei.org/advocacy/download/StockOptions-whitepaper.pdf). Due to the high cost and lack of time, it was not possible to study all the letters; therefore, we have chosen ten of them. On SFAS 148, there were 77 Comment Letters submitted; we chose Comment Letters of seven companies and two organisations.

We excluded associations of companies and professional organisations as they represent the views of a group of companies but do not use stock-based compensation expense themselves. We selected ten companies from among those whose Comment Letters we reviewed for specific investigation of how they account for stock-based compensation expense.

2.6 Quality of the Research

It is necessary to show that the research was planned and carried out in such a way that it accurately identifies and describes the phenomenon that was investigated in order to achieve a high level of credibility for the conclusions presented in this thesis. To do this, it is necessary to describe issues concerning the research project's validity and reliability (Ryan, et al., 1992).

According to Lekvall and Wahlbin (1993), validity can be divided into constructive, internal, and external validity. Constructive validity evaluates whether there is a correct relationship between theories and empirical findings. Internal validity approximates the truth about a presumption. External validity deals with the issue of whether the research actually measures the things it aims to measure.

It clarifies to what extent the findings may be duplicated when utilising the same research method, i.e., if the measurement tool would provide the same or similar results if another researcher uses the same procedure. Reliability takes into consideration the quality of measurement (Lekvall &Wahlbin, 1993).
We carefully reviewed the literature, articles, and accounting standards available to ensure the validity of our thesis, and we presented a thorough explanation of the rules governing the accounting for stock option plans and the application in practise. Based on that information, we established the main issues which raise concerns of business enterprises regarding accounting for stock-bought securities.

As we employed a qualitative research methodology, it is challenging to assess the reliability of our study; however, we can state that reliability of our study is supported by the examination of the underlying standards, Comment Letters that were available, and annual reports. Of course, the conclusions we draw in Chapter 6 are necessarily based on the limited number of companies under study.

3 Theory

This chapter discusses the idea of stock-based pay, its impact on business performance, and the FASB and IASB rules and regulations that currently apply to employee stock-based compensation schemes. In certain cases, we closely adhere to the wording of the rules themselves as we highlight the key features of the numerous restrictions. We also talk about whether a corporation incurs costs as a result of a stock-based compensation plan. The issues and challenges associated with measuring the expense and determining the timing of the expense are also covered in this chapter.

3.1 The Concept of Stock-Based Compensation

Stock options are the right to purchase a predetermined number of shares of a company's stock for a predetermined length of time at a predetermined price (referred to as the exercise or strike price) (called the option period or life of the option). Typically, businesses grant fixed options, where the number of shares and exercise price are both predetermined at the time of award. Although there are some exceptions, the exercise price is typically set to be equal to the market price of the underlying stock at the grant date and usually doesn't change over the course of the option. Employee stock options sometimes have a vesting period of several years before they become exercisable and a life of 5 to 10 years (Lynch & Perry, 2003). A "period of time over which the employee will become eligible to actually own the stock" is referred to as the vesting period (Sunkara, 2000).

Stock options are a kind of long-term compensation used by corporations. Executives and other staff are being given options as a substitute for base salary increases. (Sesil, et al., 2000) listed a few justifications for employing stock options as follows:

Employee stock options align their interests with those of shareholders. As a result, CEOs will take actions that primarily benefit shareholders.

• Options offer the chance to lower the base salary for CEOs. The significant pay disparities between executives and other workers are balanced by this.

• Options are a tax-effective method of paying employees as well.

• Options promote job growth in sectors related to knowledge.

• Options assist businesses in navigating competitive labor markets.

The sole reliance on a system of fixed wages and benefits has given way over the past 10 years to a growing role for equity.

Stakes in businesses. Companies now use stock options to organise employee compensation for larger groups of employees, expanding on the trend that was initially sparked by the explosive expansion of stock option grants to CEOs. These could replace wage rises even though they don't always go hand in hand with pay decreases (www.nceo.org/library/optionreport.html).

The tighter labour market and the meteoric rise in high technology employment and economic growth were some of the factors contributing to the increase in stock options over the past 10 years. The performance of equities has been exceptionally strong throughout that time, and there has been a rapid expansion of technological businesses, an Internet revolution, an Internet start-up boom, and significant price increases in the shares of many of these companies (Sesil, et al., 2000).

The quick spread and rapid expansion of stock option grants to CEOs marked the beginning of the move toward stock option pay. Then, mostly in high technology organisations, it spread throughout the management and professional ranks. Many businesses gradually transferred portions of future pay for larger groups of workers to stock-based compensation. 15 companies have reserved more than 25% of their weighted average number of outstanding shares for equity incentives for upper management and staff, according to a 1998 survey of the top 250 U.S. enterprises. (Weeden and others, 1998) According to this study, from 0.3% to 5% on average in the 1960s to an average of 2% in 1998, the average proportion of all shares outstanding that are allotted for remuneration has climbed.

3.2 Stock-Based Compensation Effect on Company Performance

There are numerous ideas that explain the various impacts of stock-based remuneration on business success. According to agency theory, incentive conflicts occur when top managers' objectives are at odds with those of the shareholders. Owners pay a price in the form of incentive contracts in order to better align the interests of the two parties (Jensen & Meckling, 1976).

Other ideas claim that because managers' and employees' interests are more closely aligned, stock options may reduce the cost of information in a corporation. This acknowledges that employees may have access to information that management may find useful. Employees may have the essential incentive to share or act on their superior information if there are stock-based compensation systems in place (www.nceo.org/library/optionreport.html).

An additional defence for stock option programmes comes from the efficiency wage theory, which claims that individuals who work for companies that pay above market rates may be less likely to leave and more likely to put up their best effort as a result of the higher salary rate. As a result, it's probable that employees who put in a lot of effort are drawn to businesses that provide better salaries due to broad-based stock options (www.nceo.org/library/optionreport.html).

Additionally, profit sharing theories are more likely to anticipate a favourable relationship between broad-based stock options and business performance (Kruse, 1993). Because lower level employees do in fact use stock-based compensation plans similarly to cash profit sharing plans, profit sharing theory is also pertinent to these arrangements. Thus, a more optimistic estimate is suggested by profit sharing theory. Although scholars have emphasised that it is difficult to differentiate the impacts of profit sharing from other human resource management methods, numerous microeconomic studies have revealed that profit sharing organisations are more productive than firms without profit sharing. (Kruse, 1993; Weitzman & Kruse, 1990; Ichniowski, et al., 1997).

However, some believe that stock-based pay may actually have a negative impact on business performance. Kevin J. Murphy comments on the executive stock option research tradition and claims that there is "quite scant scholarly evidence directly tying present grants to future performance" (Murphy, 1998). The claim that a company with a more extensive stock-based equity compensation scheme may achieve considerable increases in its shareholder value over time is one prominent criticism of the positive spin placed on stock options. However, if this firm is compared to the rest of its industry group, the claim that shareholders and employees profited well may be exposed as a deception if the company actually underperformed.

Due to these factors, some businesses have designed their stock option plans as follows to guarantee some form of performance beyond the norm (Sesil et al., 2000):

• Some options contain the possibility that no options will be earned and have a premium price set higher than the market price of the common stock on the date the option is granted;

• Some options won't become exercisable until the corporation meets strict performance goals;

• To ensure that the company's performance, not the performance of the market or the firm's industry group, determines the profit from the options, some options index their exercise price to a market or industry group average.

3.3 The Growth of Stock-Based Compensation

Executive and non-executive remuneration packages now often include stock options. According to a 1998 Towers Perrin research, 78% of American businesses provide stock options (Orr, 1999). It's interesting to see that non-top-five executives own the majority of stock options. 75% of stock options are given to employees who are not among the top five employees, according to a study of large companies conducted between 1994 and 1997. (Core & Guay, 2001). According to a Share Data survey conducted over a comparable time period, the percentage of companies with stock option programmes and more than 5,000 employees who issue options to all employees rose from 10 to 45%. Additionally, all of their employees receive options from 74% of businesses with less than $50 million in sales (Morgenson, 1998).

There is no reporting system that could provide accurate information on how many employees receive stock options, claims Corey Rosen, Executive Director of The National Center of Employee Ownership (NCEO). Therefore, the NCEO has created estimates based on research from the Bureau of Labor Statistics and surveys conducted by a number of significant consulting firms, including Mercer Consulting, Hewitt Associates, academics Edward Lawler, Susan Mohrman, and Gerald Ledford, as well as Segal Sibson. All of these researchers reached the same conclusions (www.nceo.org). According to these studies, between 7 and 10 million employees had stock options in the year 2000. But this does not mean that 7 to 10 million workers receive options every year, as options are frequently not awarded annually, especially in some extremely large companies with broad-based awards. Approximately three million people do that every year.

The number of Americans obtaining options is thought to have increased significantly in the 1990s; growth since 1999 is likely to have levelled off as the tech sector's development has halted. Only about one million people had choices in 1992. The expected growth through time is shown in Table 1 below (these figures reflect the number of employees who now possess options, not the number of employees who received options in a given year):

Table 1 shows the increase in US employees holding stock options. (www.nceo.org)

3.4 Stock-Based Compensation Plans – Expense or Not?

Companies are already permitted to exclude the cost of stock-based compensation from their income statements under current accounting standards. Companies can provide lucrative option packages without having an impact on their profits. Many believe that failing to expense stock-based compensation plans results in exaggerated profitability, which therefore raises share values (Sahlman, 2002).

The fair value method of accounting for stock-based compensation is preferred by FASB, and corporations are encouraged to use it in place of the intrinsic value method, which is permitted by APB 25 but often results in no expense on the income statement. Only a small percentage of businesses, meanwhile, adopt the FASB's recommendation. The debate over the accounting for stock-based compensation continues even though SFAS 123, which encourages but does not mandate the expensing of stock options, was released in 1995. A description of SFAS 123 can be found in Section 3.6.

Some businesses think that the fair value method gives investors a better understanding of the financial statements. However, some financial experts claim that since stock-based compensation is a non-cash item and is added back to net income if compensation expense is recognised using the fair value method, it will not have an impact on their valuation study (Pippolo, 2002).

3.4.1 Arguments Supporting the Recognition of Expense

One of the justifications given for using the fair value technique of stock-based compensation plan accounting has to do with the recipient's and the company's tax obligations. The difference between the received amount and the option price is taxed at a rate that is significantly lower than the rate on ordinary income when stock options are sold after complying with the holding period restrictions (Shnider, 2002). However, the difference between the option price and the stock's current market value is tax-deductible for the corporation at regular corporate tax rates. certain Americans Congressmen recommended requiring businesses that offer stock options to top executives and claim tax deductions to also include stock-based compensation expense in their income statements. It is thought to be unfair to let businesses deduct options from their taxes without having to record them as an expense (Newell & Kreuze, 1997). U.S. Congressman Pete Stark describes stock options as "...a corporate tax loophole that allows companies to hide stock option expenses from their Securities and Exchange Commission earnings reports, but allows those same companies to take the deduction on their Internal Revenue Service tax filings" (www.house.gov/stark/documents/107th/stockoptions). This bill would "End the Double Standard for Stock Options Act," which Congressman Stark introduced.

Stock-based compensations do not always result in outflows of assets or incurrence of liabilities, as stated in Statement of Financial Accounting Concepts (SFAC) No. 6, "Elements of Financial Statements." Expenses are defined as "outflows or other using up of assets or incurrence of liabilities (or a combination of both) from delivering or producing goods, rendering services, or carrying out other activities that constitute the entity's ongoing major or central operations." However, FASB contends in SFAS 123 that stock-based compensation programmes are worthwhile rewards for employees' labour. Whether the compensation is in the form of cash, other commodities, or services, the advantages stock options offer for employees result in an expense.

Furthermore, for all organisations, stock-based remuneration might really result in large opportunity costs or financial outflows. We describe these options below. Many businesses, according to Newell and Kreuze (1997), tend to maintain a constant number of outstanding shares. Companies actually sell their shares to employees at a discount when they execute stock options. Companies then use the stock market to buy shares at a higher market price in order to maintain a set number of outstanding shares. There is a genuine cost to businesses while the stock price is rising. At such time, stock options are most expensive. For instance, Microsoft reports the following in Note 15 "Employee Stock and Savings Plans" of its Annual Report 2002: "The Company has an employee stock purchase plan for all eligible employees. Shares of the Company's common stock may be purchased under the plan at intervals of six months for 85% of the lower of the market value or the exercise price (www.microsoft.com/msft/ar). The company repurchases its common shares in the open market to provide shares for issuance to employees under stock option and stock purchase schemes, according to Note 13 "Stockholders' Equity" (www.microdoft.com/msft/ar). As can be seen, when stock options are exercised, corporations do pay more for their shares on the stock market. Unless corporations voluntarily choose to employ the fair value based technique for accounting for stock-based compensation, these options are not recognised as a cost. In the end, though, these solutions cost businesses actual money.

There is also an opportunity cost for businesses, as was already mentioned. The corporation sells its stock to employees at a discount when they execute their stock options. The difference between the exercise price and the higher market price is that discount. Even if the corporation chooses not to purchase its shares in the market, it incurs costs. The business forfeits its chance to sell these shares on the market for a higher price. Since the exercise price is lower than the greater market price, the opportunity cost is the difference (Newell & Kreuze, 1997).

3.4.2 Arguments For No Expense Recognition

Despite the numerous arguments in favour of treating stock-based remuneration as an expense, there are numerous opponents. According to Borrus et al. (2002), the primary objections to the idea of expensing stock-based compensation plans are as follows:

Why Companies incur no monetary expense as a result of stock option grants, unlike salaries or other forms of compensation. Expensing stock-based compensation programmes will only have a negative and unjustifiable impact on a company's profitability because there is no expense that can be deducted.

• No specific techniques have been devised to quantify stock-based compensation costs. All valuation techniques call for several estimations and assumptions.
Financial statements may become less accurate as a result of this circumstance, which also makes manipulation easier.

• Earnings will be decreased by the deduction of stock-based compensation expense.

• It could cause share values to decline.

• Businesses may start issuing fewer options in order to protect their profits. This will make it harder for businesses to retain talented workers and prevent them from balancing the interests of their workers and shareholders.

Finally, expensing stock-based compensation programmes won't provide any new information that isn't already there in the financial statements, according to Sahlman (2002). Instead, it can result in less information being included in the financial statements' footnotes and a more misleading image of a company's financial situation.

3.5 Methods to Measure Stock-Based Compensation Expense

This section covers numerous techniques for estimating potential costs associated with stock-based compensation programmes. Some of the suggested techniques are based on models for option pricing. We briefly define a few words used in reference to options, their pricing, and how they apply to stock-based compensation programmes to start off this section. Following these explanations, we provide a summary of the models used to price stock options along with some remarks on the challenges associated with their use.

3.5.1 Explanation of Option-Specific Terms

The preset price at which the option's writer and holder both concurred and at which the option's holder can purchase or sell an underlying asset is known as the striking price or exercise price (Ross, et al., 1996).

Regarding expiration, there are primarily two types of options: European options and American options. American options can be exercised at any time after they have vested, whereas European options cannot be exercised before the expiration date (www.e-analytics.com/optbasic).

The following factors can affect an option's price (www.e- analytics.com/optbasic):

• The underlying asset's cost
• The option's actual strike price
• The amount of time until the expiration date
• The stock's underlying volatility (in case of stock options)
• Dividends anticipated on the underlying stock
• The interest rate that is risk-free for the anticipated duration of the option.

Undoubtedly one of the most important elements is stock volatility. The propensity of the stock to experience price movements is referred to as volatility. The terms historical, predicted, and implied volatility are all explained at www.mdwoptions.com/volatility. The stock's actual price movements from the past are used to compute historical volatility. The stocks expected volatility from the date of option issuance until the expiration date, however, is more crucial to understand. Given that the time horizon lies in the future, volatility in this situation is difficult to exactly assess. Therefore, the volatility needs to be calculated. Forecast volatility refers to the anticipated future volatility. On the other hand, implied volatility refers to the option rather than the underlying stock (www.ivolatility.com/news).

Stock-based compensation plans can be valued at either intrinsic or fair value, as was previously mentioned. Under the intrinsic value based theory (see Section 1.2),approach, the cost of compensation is acknowledged as an intrinsic value at the time of grant. The intrinsic value is the difference between the underlying stock's current market price and the option's exercise price. Since the exercise price of the option on the grant date is typically equal to the fair value of the underlying stock, this strategy typically results in no expense for stock option awards (Pippolo, 2002). The compensation cost is recognised and expensed for the period that an employee provides associated services when an expense is determined using the intrinsic value technique (i.e., when the market price is not equal to the exercise price at grant date). The corporation must also provide pro forma net income and earnings per share using this methodology, just as it would have under the fair value-based methodology (Wiedman & Goldberg, 2001).

The compensation cost is calculated at the award date and recognised over the service duration, which is often the vesting period, under the fair value based method. An option pricing model is used to calculate the fair value. The grant date, the exercise price, the expected life of the option, the present price of the underlying stock, that stock's anticipated volatility, expected dividends on that stock, and the risk-free interest rate over that same estimated life are all taken into account by option pricing models. The fair value technique results in a larger expense than the intrinsic value approach because the fair value of an option includes both its intrinsic value and its time value (Wiedman & Goldberg, 2001).

3.5.2 Overview of Option Pricing Models and Their Drawbacks When Applying to Stock-Based Compensation Plans

Use of option pricing models can be used to determine the stock-based compensation's fair value. Companies have the option of assessing stock options using option pricing models, thanks to both IASB and FASB. Here, we give a succinct overview of the models that are offered.

The Black-Scholes and binominal models, which offer fairly accurate estimations of an option's value, are the most often used option pricing models (www.ei.com/publications/2001/winter1). The Black-Scholes model, co-created by Robert Merton and launched in 1973 by two financial professors, Fischer Black and Myron Scholes, is typically preferred by businesses. The Black-Scholes and binominal models are formulas that produce an expected of value stock option, which is the amount that an investor is ready to pay today for the chance to profit from the rise in value of the underlying stock during the option's lifetime (Restaino, 2001).

The following assumptions are included in option pricing models (www.bradley.bradley.edu):

• No dividends are paid for the duration of the option.
• Exercise terminology from Europe.
• Markets are productive.
• No commission fees are assessed.
• The interest rate is stable and well-known.

Publicly traded short-term investment instruments are employed in the Black-Scholes model and standard binominal models. They therefore cannot be applied to value employee stock options without being modified. In reality, according to these option pricing models, the value of employee stock options can be greatly inflated (www.ei.com/publications/2001/winter1). The Black-Scholes model is suitable for publicly traded options, but it should not be used for employee stock options, according to Alfred King, vice chairman of Valuation Research Corp. in the United States (Harrison, 2002). A number of businesses have also pointed out the shortcomings of the current option pricing models, including Wal-Mart and Commerce Bancorp Inc. The companies claimed in their annual reports that the current option pricing models do not accurately reflect the fair value of employee stock options because employee stock options differ from traded options and because option valuation methods demand a lot of subjective assumptions that can affect the valuation (Harrison, 2002).

Accountants must use their expert judgement when determining the expected stock volatility, estimated duration of the option, and projected dividends. Accountants should take dividend history into account when estimating dividends. There is a chance that the past dividend payout won't continue. Accountants must devise a new method to estimate dividends in such circumstances. The vesting time affects the expected life of options. The corporation should use the typical period of time during which comparable grants were outstanding in the past if there is any indication that options may be exercised sooner. The most difficult estimate to make is for the projected volatility. Once more, accountants should consider the stock's historical volatility (Bushong, 1996).

Employee stock options are very different from publicly traded options in that they are far longer-term, can be exercised at any time, and can be freely traded. Employee stock options often have a longer life span, can be exercised during a lengthy vesting period, and, most crucially, are not transferrable (Harrison, 2002).
A key restriction on employee stock options is their non-transferability. The assumption used by standard option pricing models is that options will be executed at or very nearly the ideal exercise price Options' transferability makes sure they won't be exercised too soon. For instance, if the option holder decides they do not want to keep the option until the right exercise date, they can sell it to another investor who will keep the option until the right time. The transferable options may be transferred but will not be exercised in advance. In the case of employee stock options, there is only one option available if the option holder wants to sell the stock: exercise the option, even if the timing is unsuitable and the value received would be subpar (www.ei.com/publications/2001/winter).

Additionally, employee stock options—which traded options do not—can have a reload feature. When original choices are exercised, a reload mechanism instantly grants a new set of options to the executive. The market price of the company's shares on the date the original options are exercised is typically the same as the exercise price of the option with a reload feature. A reload feature makes an option more useful than a standard choice. The benefit of exercising current options while still retaining options for future exercises is available to the holder of the reload option (Saly & Jagannathan, 1999).

As a result, the option pricing model that can be altered to account for the unique characteristics of employee stock options is the one that would accurately assess the value of employee stock options.

The issue of the exercise time is another issue with the measurement of stock options. Whether to measure stock options at a grant date or a vesting date is up for debate. What would be the fair value of the stock option, which the employee may exercise in five, ten, or possibly never, if the measurement date is the grant date? (1995, Cheatham). The issue of stock option measurement is made more difficult by the possibility of early exercise. Employees may decide to exercise their options before they are ready in order to reduce their risk exposure. Therefore, if the actual terms differ from those estimated, it will eventually be essential to change the estimated expense in order to eliminate measurement mistakes (Hemmer & Matsunaga, 1994). These issues are understood by FASB and IASB. Both SFAS 123 and Exposure Draft
2 mandate that the stock options be valued using their expected lifetimes rather than their contracted lives due to the likelihood of early exercise.

3.6 Accounting for Stock-Based Compensation in the United States Prior to SFAS 123

Long a contentious topic, stock-based compensation accounting should compensation expense be recorded for stock options? These are the two issues that have dominated the standard-setting process for stock-based compensations. If so, over what timeframes should it is distributed? (www.nysscpa.org/cpajournal/2001/0500/ features). The American Accounting Principles Board (the APB) published Opinion No. 25 (APB 25), "Accounting for Stock Issued to Employees," in October 1972. The intrinsic value of the granted options is used by APB 25 to determine compensation. The difference between an option's exercise price and the stock's current price at any time during its life is what is known as the option's intrinsic value (Brozovsky & Kim, 1998). The amount of compensation is decided at the measurement date according to APB 25. The measuring date is the first day on which the employee will know how many shares they will get as well as the exercise price. This is typically a grant date (Brozovsky & Kim, 1998). However, the market price and exercise price are often equal at the grant date. Therefore, according to www.orgs.comm.virginia.edu/mii/education/fundamentals, firms do not record any compensation expense for stock options.

3.7 The History of SFAS 123 “Accounting for Stock-Based Compensation”

The method permitted by APB 25 did not satisfy the accounting professionals since it disregarded the potential that the stock price would one day rise above the exercise price. To create a new standard, FASB spent eleven years (1984–1995) working on it (www.fwcook.com). The corporations were compelled to measure the expense of stock options at their fair value and display it on their income statement when FASB released an Exposure Draft of a new standard in 1993. The business community, however, vehemently opposed the Exposure Draft. The Statement of Financial Accounting Standard No. 123, entitled "Accounting for Stock-based Compensation," was eventually published by FASB in October 1995 (www.online.wsj.com/article). Companies are permitted, but not required, by SFAS 123 to measure compensation expense using the fair value technique. Companies are required to calculate compensation expense using an award's value as of the date it is awarded under the fair value approach. Businesses are permitted to keep employing APB 25, but they must disclose how SFAS 123 might affect their net income and earnings per share. Because of this disclosure requirement, every business that grants employee stock options must conduct the computations outlined in SFAS 123. (Brozovsky & Kim, 1998).

Following the 2001–2002 U.S. accounting scandals, an increasing number of businesses decided to expense the cost of employee stock options. Only two of the Standard and Poor's 500 corporations were expensing the cost of stock options as of mid-July 2002. More than 90 businesses declared their intention to follow suit by the middle of September 2002. This is a blatant example of how politics and public opinion can affect company behaviour (Levinsohn, 2002).

The FASB announced its plan to carry out a limited-scope project linked to the SFAS 123 transition provision in its news release from July 31, 2002, which also emphasised the benefits of applying the standard (www.fasb.org/news/nr073102).

The Accounting for Stock-Based Compensation - Transition and Disclosure Exposure Draft, published by FASB on October 4, 2002, would change SFAS123.This revision was issued primarily for the following two reasons (www.fasb.org/news/nr100402):

• To make it possible for businesses those decide to use the fair value-based technique to immediately begin reporting the full impact of employee stock options in their financial statements;

• To give investors and other consumers of financial statements better and more frequent disclosures concerning the price of employee stock options.

The modification was published on December 31, 2002, as SFAS No. 148.

Sections 3.9 and 3.10 provide a more thorough discussion of SFAS 123 and SFAS 148, respectively.

3.8 The History of Accounting for Share-Based Compensation by IASB

On share-based compensation, there is no established International Financial Reporting Standard. The expanding number of businesses implementing share-based compensation has made this gap in the International Accounting Standards sector a major concern. The "Employee Advantages" section of International Accounting Standard (IAS) No.19 addresses equity compensation benefits in part. It only addresses the disclosure requirements, though. As a result, the International Accounting Standards Committee (the IASB's predecessor) released a Discussion Paper titled "Accounting for Share-based Payment" for feedback from the general public in July 2000. The IASB decided to continue working on the Discussion Paper in July 2001 in order to turn it into an Exposure Draft. Some IASB members were worried that preparers who opposed including stock option expensing in the income statement may criticise them for failing to follow due procedure (The Economist, November 2002, Vol. 365, Issue 8298). So, in September 2001, the IASB asked for more feedback on the Discussion Paper, which was to be sent by December 15 of the same year. The IASB released Exposure Draft 2 "Share-Based Payment" on November 7, 2002, following careful review of the feedback received and with the help of the project's Advisory Group, which was made up of people from various nations (www.iasb.co.uk). By March 7, 2003, comments on this Exposure Draft must be sent. The standard's final version is anticipated to be released in late 2003 and go into effect on January 1, 2004. In accordance with the formal draft's publication date (http://online.wsj.com/article/0SB102686178947884200.html), it would administer all options given.

3.9 Examination of FASB Statement No. 123 “Accounting for Stock-Based Compensation”

Standards for financial accounting and reporting are set forth in this Statement (published in 1995) for stock-based employee compensation programmes. The Statement applies to all agreements under which the employer incurs liabilities to its employees in amounts depending on the price of its stock or grants shares of stock or other equity instruments to employees.

The Statement also applies to business dealings in which a firm issues stock instruments to pay for goods or services from third parties who are not its employees. In these circumstances, the fair value of the payment received or the fair value of the equity instruments issued must be used to account for the goods or services (SFAS 123, par. 6).

There are various accounting methodologies available for stock transactions involving workers under SFAS 123. The fair value-based technique of accounting for stock-based compensation plans is established in this Statement. The intrinsic value based method of accounting specified by APB 25 can still be utilised to calculate the compensation costs for the plans, but it encourages organisations to choose this way of accounting in lieu of the APB 25's "Accounting for Stock Issued to Employees" provisions. Entities that choose to continue using the intrinsic value-based method must disclose net income and, if presented, earnings per share, on a pro forma basis as if the fair value-based methods were still in use.

A method of accounting had been used to calculate the cost of compensation (SFAS 123, par. 11).

A corporation should account for all of its stock-based employee pay agreements using the same accounting approach, either the fair value-based method or the intrinsic value-based method (SFAS 123, par. 14).

Typically, previous or future services are used as part of the consideration for stock instruments offered to employees. The fair value of any equity instruments provided to workers will be used to determine how much the cost of the services received in exchange will be (SFAS 123, par.16).
When employees become entitled to stock options or other equity instruments after completing the necessary service requirements and satisfying all other requirements to earn the right to benefit from the instruments, measurement is made estimating the fair value based on the stock price at the grant date of the instruments (SFAS 123, par 17).

As of the grant date, the exercise price and expected life of the option, the current price of the underlying stock and its anticipated volatility, anticipated dividends on the stock, and the risk-free interest rate for the anticipated term of the option are all factors that go into determining the fair value of a stock option (or its equivalent) granted by a public company (SFAS 123, par. 19).

A non-public firm must assess the value of its options using the same criteria as public companies, but it need not take into account the stock's anticipated volatility over the option's anticipated life (SFAS 123, par. 20).

Most stock options and other equity instruments can typically have their fair value estimated at the time of grant. Otherwise, the fair value based on the stock price and other performance factors at the first date at which it is reasonably reasonable to assess such value shall be the final measure of the compensation cost. Estimates of compensation costs for periods during which the fair value cannot be determined must be based on the award's present intrinsic worth (SFAS 123, par. 22).
The amount of instruments that eventually vest will determine the compensation cost recognised for the grant of stock-based employee pay. Awards that employees forfeiture due to failure to satisfy service requirement for vesting, such as for a fixed award, or due to the company's failure to meet a performance condition are not subject to compensation costs (SFAS 123, par. 26).

The quantity of options or other equity instruments that are anticipated to vest may be best estimated at the time of award. If additional information shows that actual forfeitures are likely to differ from early projections, the corporation may decide to update that estimate as needed. A corporation may also start incurring compensation costs as if all awarded instruments that are simply subject to a service requirement are expected to vest. The impact of actual forfeitures would then be understood as they take place (SFAS 123, par. 28).

If the award is for future services, the equity award will be credited with the equivalent amount of compensation cost, which will be recognised during the period(s) in which the linked employee services are performed. If the service period isn't specified as being sooner or shorter than that, it will be assumed to be the time from the grant date until the award becomes vested and is exercisable regardless of how long the employee continues to work for the company. The corresponding compensation cost must be recognised in the period in which the award is issued if it is for prior services (SFAS 123, par. 30).

Regardless of the chosen accounting technique, the employer must make specific disclosures about stock-based employee compensation plans in its financial statements. The plan(s) must be described by the corporation, including vesting conditions, the longest option term permissible, and the amount of shares authorised for option awards or other equity instrument grants (SFAS 123, par. 45).

3.10 Examination of FASB Statement No. 148 “Accounting for Stock-Based Compensation – Transition and Disclosure”

The FASB modified SFAS 123 by issuing an Exposure Draft on October 4, 2002, titled "Accounting for Stock-Based Compensation - Transition and Disclosure." Accounting for Stock-Based Compensation - Transition and Disclosure" was published by FASB as SFAS No. 148 on December 31, 2002 (www.fasb.org/news/nr123102.shtml). The ED is the basis for SFAS 48.

We now examine the Statement's two major components: the Amendment to Transition Provisions and the Amendment to Disclosure Provisions.

Companies who used the fair value-based method were required by SFAS 123 to apply this method prospectively for newly awarded share options. This resulted in investors and businesses were concerned about the so-called "ramp-up" effect on stated compensation costs because the results were inconsistently disclosed. FASB was worried that applying the fair value approach retroactively would cause issues for those who produce financial statements since it would be difficult to find the historical data needed to calculate the fair value of shares or options given prior to the implementation of SFAS 123. SFAS 148 offers two more transitional approaches to help businesses that want to use fair value to measure shares or options given. By immediately adding the company's stock-based compensation expenditure after adoption, both techniques eliminate the ramp-up effect. Currently, if the firm chooses to use the fair value method of accounting for share option plans, the three options listed below are permissible under the change to Transition Provisions, paragraph 52 of SFAS 123:

a. To all share options granted to workers, or share options modified or settled, following the start of the fiscal year in which this method is implemented for the first time, the corporation may apply the fair value-based method of accounting for share option programmes.

b. As of the beginning of the fiscal year in which the fair value based method of accounting for share options was first applied, the company may recognise stock-based employee compensation costs as if this method had been used to account for all employee share options granted, modified, or settled in fiscal years beginning after December 15, 1994.

c. For all employee share options granted, modified, or settled in fiscal years beginning after December 15, 1994, the firm may restate all periods that represented stock-based employee compensation expense utilising the fair value based accounting technique.

Regardless of the accounting technique adopted, SFAS 148 enhances the clarity of disclosures about the pro forma effects of using the fair value based approach of accounting for stock-based compensation for all organisations. It updates SFAS 123's paragraph 45 and mandates that all businesses explain how they accounted for stock-based employee remuneration throughout each reported quarter. If the business uses the fair value-based approach, it must explain how it reported the change in accounting standards. If the company chooses to use the intrinsic value method, it must disclose pro forma amounts and differences, if any, in the cost of stock-based employee compensation that would have been included in net income as well as any additional tax consequences if the fair value method had been chosen instead.
Additionally, the timing of disclosure has been enhanced. Companies must provide information in their annual and interim financial statements in accordance with SFAS 148.

3.11 Examination of the IASB Exposure Draft 2 “Share-Based Payment”

IASB published Exposure Draft 2 (ED) "Share-Based Payment" on November 7, 2002. The ED is divided into three sections (www.iasb.co.uk):

• Share-based Compensation

• Basis for Conclusions: Share-based Payment

• Draft Implementation Guidance for Share-Based Payment

The draught mandates that all share-based payment transactions, including those that will be settled in cash, other assets, or company equity, be disclosed in a firm's financial statements.

Three different sorts of transactions are described in ED 2, paragraph 3:

• Share-based payment transactions with an equity settlement

• Share-based payment transactions with cash settlements.

• Transactions in which the firm receives or pays for goods or services and has the option to pay for the transaction in cash, in amounts dependent on the price of the company's shares or other equity instruments, or by issuing equity instruments.

Here, we will focus on equity-settled share-based payment transactions, with a particular focus on the debate surrounding employee stock options and the issue of share options issued to employees.

When actual acquisition or purchase of the products or services covered by a share-based payment transaction occurs, the corporation must record such transactions. If the acquired items or services are not eligible for asset recognition, they must be expensed (ED 2, par.4).

The corporation must also measure equity-settled share-based transactions directly at the underlying fair value of the products or services acquired in such transactions or indirectly by reference to the fair value of the equity instruments granted, according to the established regulations. Choose either the direct or Using an indirect approach depends on how simply determinable the fair value is (ED 2, par. 7).

The corporation then has two options for the time of transaction recognition. If the fair value is calculated directly, it should be established on the day the business acquires the goods or services. If the fair value is determined indirectly, the grant date should be used to determine it (ED 2, par.8).

It is considered that the fair worth of the goods or services received for transactions with parties other than workers is simpler to ascertain because there is typically an established market for those goods and services (ED 2, par.10). However, the question of determining fair value becomes more challenging when dealing with transactions involving employees. Employees typically receive share options as a part of their compensation. As a result, it is impossible to evaluate the fair value of the services provided by a specific component of an employee's compensation directly. Therefore, since determining the fair value of equity instruments provided is easier than measuring the fair value of employee services received, the corporation should do so (ED 2, par.12).

According to ED, if the company's shares are traded openly, the fair value of the shares given should be calculated using the share price at market. In the absence of that, the business must estimate the market price (ED 2, par.19).

The market price of traded options with comparable terms and conditions should be used to determine the fair value of granted options. The terms and circumstances of granted options are different from those of traded options, hence frequently such traded options do not exist. In these situations, the business should utilise an option pricing model to determine the estimated fair value of the issued options. ED suggests using a binominal model or the Black-Scholes model.

The exercise price of the option, the duration of the option, the current value of the underlying asset, the anticipated volatility of the share price, the anticipated dividends on the shares, and the risk-free interest rate for the duration of the option should all be taken into account when using an option pricing model. (ED 2, par.20).

In ED, the difference between the option's contracted life and its expected life is made. The time between the grant date and the anticipated exercise date of an option is known as the expected life. It is preferable to utilise the option's expected life rather than its negotiated life for non-transferable options.
Given that employee share options are non-transferable, it is especially crucial in this situation (ED 2, par.21).

Expected dividends should be taken into account when the corporation calculates the fair value of options or shares awarded (ED 2, par.23).

When determining the fair value of options or shares, any unique vesting requirements that must be satisfied should also be taken into account. For instance, the granting of options or shares to employees is typically contingent upon their continued employment with the company for a predetermined period of time (ED 2, par.24).
Companies are required by ED to give thorough disclosure regarding the shares or options given. Companies are required to disclose information like the amount and weighted average exercise price of options, as well as a description of each type of share-based payment arrangement. Companies should also make information available that would help readers of financial statements understand how the fair value of given shares or options was calculated. Additionally, it is necessary to disclose how expenses related to share-based payment transactions affect the profit and loss statements of the companies (ED 2, par.45-53).

3.12 Invitation to Comment “Accounting for Stock-Based Compensation: A Comparison of FASB Statement No.123, Accounting for Stock-Based Compensation and Its Related Interpretations, and IASB Proposed IFRS Share-Based Payment”

In order to strengthen U.S. financial accounting and reporting standards and to encourage the convergence of high-quality accounting standards internationally, FASB published this Invitation to Comment in November 2002. FASB is requesting opinions on a number of problems that it will be discussing. The deadline for these comments was February 1st, 2003. The Invitation to Comment seeks perspectives on the distinctions between IASB Proposed International Financial Reporting Standard, "Share-Based Payment," and SFAS No. 123, "Accounting for Stock-Based Compensation," and its related interpretations (ED 2). Additionally, the Invitation to Comment solicits opinions on many facets of accounting for stock-based compensation at fair value based on these disparities.

Both standards are founded on various principles, as indicated in the Invitation to Comment. The basic goal of ED 2 and SFAS 123 is to measure and recognise the fair value of the products and services acquired in exchange for equity instruments in order to account for stock-based compensation. The vicinity of a modified grant-date fair measurement method is used by SFAS 123 for transactions involving employees. The grant date method is used because the fair value of the award is initially determined at that date, and the vesting date method is used because compensation costs associated with the award are adjusted for subsequent events, such as actual forfeitures and actual results of performance conditions.

As a practical expedient, ED 2 applies a variation of the grant-date fair value measuring approach to transactions involving employees. The approach of measuring by vesting date is not used. In order to account for any forfeiture brought on by failure to complete the vesting conditions, ED 2 recommends discounting the fair value of an equity instrument as determined at grant date. In order to calculate the total compensation expense, multiply the number of service units received throughout the vesting period by the discounted fair value per unit of service established at the award date. Even if the issued equity awards are forfeited, amounts recognised for employee services are not thereafter reversed. According to SFAS123, the effect of potential forfeitures owing to failure to complete the vesting conditions should not be taken into account when determining the fair value of an equity instrument at the grant date. The number of vested equity instruments multiplied by the fair value of each equity instrument as of the award date should be used to calculate aggregate compensation expenditure. If the granted equity awards are forfeited, the amounts recognised for employee services throughout the vesting period are subsequently reversed.

When it comes to stock-based compensation accounting utilising the fair value-based method, the Invitation to Comment compares and contrasts SFAS 123 and ED 2. Scope, recognition, measurement, disclosure, and transition are the five key areas used to group these similarities and differences.

Table 2 lists the most significant parallels, whereas Table 3 lists the most significant distinctions.

Table 2 lists the key commonalities between SFAS 123 and ED 2.

Table 3: The most important differences between SFAS 123 and ED 2

The Invitation to Comment summarises the key and secondary similarities and differences between SFAS 123 and ED 2, but it does not identify all of them. A review of the ED 2 was encouraged by the invitation to comment in order to advance the global convergence of superior accounting standards.

4 Empirical Findings

We give the empirical data gathered throughout our research in this chapter. We examine a number of Comment Letters on FASB SFAS 123 "Accounting for Stock-Based Compensation," FASB SFAS 148 "Accounting for Stock-Based Compensation - Transition and Disclosure," and IASB Discussion Paper on Share-Based Payments that were submitted by various businesses and professional associations (Discussion Paper). We also investigate how businesses present the cost of stock-based remuneration in their financial statements.

4.1 Review of Comment Letters Submitted to the ED for SFAS 123

We have chosen the Comment Letters from ten significant and renowned representatives of their industries - manufacturers, auditors, analysts, and high-tech companies - from more than 700 Comment Letters submitted on the Exposure Draft SFAS 123 (www.fei.org/advocacy/download/StockOptions-whitepaper.pdf). Letter dates are indicated in parenthesis.

• Deloitte & Touche, Ernst & Young, KPMG Peat Marwick, Price Waterhouse, Arthur Andersen & Co., Coopers & Lybrand (1994).
• Boston Security Analysts Society (1993).
• Company: Coca-Cola (1993).
• The company Chase Manhattan (1994)
• Merrill Lynch and Company, Inc. (1993)
• Oracle System Corp. (1994)
• The LTV Steel (1993)
• Corporation Intel (1994)
• J.P. Morgan (1994)
• BankAmerica Corp. (1993)

To describe the nature of each respondent's business, descriptions of each respondent are given.

4.1.1 Arthur Andersen & Co., Coopers & Lybrand, Deloitte & Touche, Ernst & Young, KPMG Peat Marwick, Price Waterhouse

In a single Comment Letter, the six largest auditing firms—Arthur Andersen & Co., Coopers & Lybrand, Deloitte & Touche, Ernst & Young, KPMG Peat Marwick, and Price Waterhouse—expressed their views. The Exposure Draft "Accounting for Stock-Based Compensation" was rejected by all of these auditing firms, as was stated in the vast majority of the 1700 Comment Letters.

These auditors claim that the fair value measurement approach will further damage the credibility and comparability of financial statements and that it has not been accepted to reflect the fair value of employee stock options. In light of this, using extended disclosures is the best option.

4.1.2 The Boston Security Analysts Society

Since 1946, the non-profit Boston Security Analysts Society has served as a hub for one of the most important investing communities in the world, offering a public forum for the sharing of novel viewpoints on contemporary business concerns. Boston Security Analysts Society promotes camaraderie, ethics, and professional progress among investment professionals in the Boston area through a variety of activities and training initiatives. Society gatherings are frequently hosted in Boston's financial sector, which offers accessible and distinctive opportunities to gain knowledge from colleagues, mentors, and leading professionals in the field. The Association for Investment Management & Research, which has more than 50,000 members worldwide, was founded by the Boston Security Analysts Society, which has more than 4,000 members who work in the investment industry (www.bsas.org).

The only one of the ten Comment Letters we examined that fully endorsed the proposed Statement of Financial Accounting Standard was that from the Boston Security Analysts Society on the Exposure Draft "Accounting for Stock-Based Compensation." The Boston Security Analysts Society agreed that the value should not only be stated in footnotes but also recognised in financial statements. Nevertheless, it also expressed its concern regarding "the potential significant impact on reported earnings and the earnings volatility of small companies as well as substantial concern regarding the use of volatility measures in determining employee stock option values where no liquidity exists for significant periods of time."

4.1.3 The Coca-Cola Company

The Coca-Cola Company (Coca Cola) is the top producer, marketer, and distributor of non-alcoholic beverage syrups and concentrates in the world, contributing to the creation of more than 300 beverage brands (www2.coca-cola.com).

Coca-Cola firmly disagreed with the Exposure Draft on "Accounting for Stock-Based Compensation," stating that "the proposed accounting rules would not enhance the overall usefulness and reliability of our financial statements and, in fact, would provide a result that is less meaningful to the users of financial statements than the current rules" Coca-Cola also voiced its opinion on the following three matters:

Valuation of traded stock options versus non-traded employee stock options

Due to the lack of a valid and impartial measurement method and the fact that "option pricing models were designed to value traded options," which lack features like vesting restrictions, performance requirements, and non-transfer clauses, Coca-Cola disagreed with the recognition of compensation expense.

Subjectivity of certain assumptions

Coca-Cola used the Black-Scholes options pricing model to perform preliminary estimates for the year's issue of employee stock options for the corporation in order to demonstrate the significance of such assumptions as stock volatility and dividend yield. Calculation results revealed that the range of plausible assumptions "would generate a fluctuation in value up to 33 percent" and "lower the credibility and relevance of our financial statements."

Cost-benefit considerations

The key time and effort commitments for employing the fair value measuring approach for stock-based remuneration were listed by Coca-Cola as follows:

-choosing the best factors to employ (dividend yield, stock volatility);
-informing senior management of the details of the new rule
-informing and interacting with investors;
-developing and deploying accounting systems to handle the required bookkeeping needs.

The corporation came to the conclusion that the more time-consuming and labor-intensive fair value measuring approach "would provide very subjective outcomes that can't be verified" for stock-based remuneration.

4.1.4 The Chase Manhattan Corporation

The retail financial services division of JPMorgan Chase is called The Chase Manhattan Corporation (Chase). The union of JPMorgan Chase & Co. and The Chase Manhattan Corp. Incorporated, which united one of the biggest commercial banks in the world with a reputable and significant investment banking organisation, was completed in December 2000 (http://www.jpmorganchase.com/cm/cs?pagename=Chase/Href&urlname=jpmc/about/history).

Due to the fact that "the issuance of stock options represents a capital transaction, not one that requires a charge against earnings," and also because "no reliable or consistent methods currently exist for determining the fair value of employee stock options," Chase disagreed with the Exposure Draft "Accounting for Stock-Based Compensation" proposal to recognise the compensation expense in the financial statements.

Additionally, the business commented on the following things:

Measurement Date

Chase concurred with the Exposure Draft's stance that the stock price at the award date should be used to calculate the cost of stock-based compensation.

Measurement Method

Due to the lack of a reliable method for determining the fair value of stock options, Chase opposed the idea that the fair value method should be the primary measurement method. "Determination of fair value as proposed is basically subjective and includes numerous variables, calling into question its validity, and making comparisons among entities virtually impossible," said Chase.

In addition, Chase opposed permitting multiple approaches to determining the value of employee stock options for private corporations since doing so would "just exacerbate the problem of comparability."

Chase claims that reducing the value of an employee stock option to reflect its non-transferability should be done in a non-arbitrary manner. The actual life of an employee stock option should not be used to determine its value since it will produce "further distorted results, i.e., a fall in stock price after the option's grant date lengthens the exercise period, necessitating the recognition of additional compensation expense."
Attribution Period

According to Chase, "the vesting time should be utilised to the degree that remuneration is required to be recognised."


Chase concurred that disclosure might be a better option than accounting for compensation expenses.
Effective Dates and Transition

According to Chase, the standard must have been in effect for at least a year. The company also thinks it will be useful to employ the planned three-year pro forma disclosures before the standard's recognition requirements must be enacted.

4.1.5 Merrill Lynch & Co.

With offices in 36 countries and total client assets of nearly $1.3 trillion, Merrill Lynch & Co., Inc (Merrill Lynch) is one of the top financial management and consulting firms in the world (www.ml.com/about ml.htm).

Due to the fact that "granting of stock options is a capital transaction that represents only a potential future dilution of stockholders' equity," Merrill Lynch stated that the value of employee stock options should not be recorded as compensation expense. Additionally, Merrill Lynch, like the majority of the other companies mentioned above, agreed that there is no objective method for estimation of the appropriate fair value of an employee stock option because stock option pricing mode.
The following topics were addressed in the company's opinions:

Recognition of Compensation Cost

Merrill Lynch claims that, "To achieve the best theoretical accounting result, companies should bifurcate restricted stock-based compensation awards into expense and capital components, and apply a discount (at the grant date) to the fair values (derived from option pricing models) for illiquidity," but the firm acknowledges that this would be extremely challenging to put into practise. In order to "achieve a more realistic fair value for restricted stock options, eliminate the subjective volatility factor, and promote consistency and comparability of financial statements," Merrill Lynch advises using the minimum value method to record the income statement effect of stock option grants.

Measuring Method

Instead of the Exposure Draft "Accounting for Stock-Based Compensation" recommendation to adjust compensation expenditure by documenting the difference between the projected and the actual stock options' lifetimes, Merrill Lynch advised using the option vesting period to calculate compensation expense. Because it would be "administratively cumbersome and skew the metrics of financial performance," the corporation objected to the FASB's suggested method.

4.1.6 Oracle System Corporation

The second-largest independent software firm in the world and the world's top provider of information management software is Oracle System Corporation (Oracle) (www.oracle.com).

Oracle vehemently opposed the FASB Exposure Draft "Accounting for Stock-Based Pay" proposal that would have required businesses to deduct employee stock-based compensation from earnings. The business provided three primary justifications for its position:

- Oracle's capacity to grant stock options would be adversely affected by the plan.
- It would make it harder for high-tech businesses to compete in the global market.
- Less accurate financial reporting would result.

The measurement problem exists because there is no method that could exactly estimate: Oracle was particularly concerned about the Black-Scholes model, which the company claimed would "create confusion, inconsistency, and inaccuracies in corporate financial reporting."

- The restriction on employee stock options being transferred;
- Their capacity for long-term exercise;
- The need for on-going employment in order to exercise the options;
-Future volatility in stock prices;
- Variations in vesting timelines;
- Price adjustments that are unrelated to a company's performance on the market.

In order for shareholders to decide whether this FASB Exposure Draft "Accounting for Stock-Based Compensation" should be implemented, Oracle advised FASB to include theoretical valuation under the Black-Scholes model in the footnotes to companies' financial statements.

4.1.7 LTV Steel Corporation

A manufacturer having interests in the steel and steel-related industries is the LTV Steel Corporation (LTV Steel). LTV Steel submitted voluntary petitions for relief under Chapter 11 of the U.S. together with 48 subsidiaries. Code of Bankruptcy on December 29, 2000 (www.ltvsteel.com).

The Exposure Draft "Accounting for Stock-Based Compensation" was vehemently opposed by LTV Steel, which preferred a disclosure-based strategy. LTV Steel disagreed that employee stock-based compensation costs should be reported in financial statements because "the recognition of non-cash charges of employee stock award transactions, that do not affect cash flows or net equity, does not appear to be important in assessing the financial performance or condition of an enterprise"

Valuation of Employee Stock Options

Due to significant discrepancies between traded options and non-traded employee stock options, LTV Steel claims that "current option pricing techniques are extremely subjective and do not yield a meaningful or relevant value for employee stock options." Because employee stock options "don't trade and, because the assumptions used in the models are extremely subjective and produce an amount that is never verified in an actual transaction," LTV Steel came to the conclusion that it might be impossible to develop a consistent option pricing for employee stock options.

Use of Expected Term to Determine Expense and Value Options

The suggestion in the Exposure Draft "Accounting for Stock-Based Compensation" to calculate the value of the option using the expected term on the grant date and then modify it using the actual term is opposed by LTV Steel because it produces "unnecessary complexity and improper results."

In order to inform readers of financial statements about employee stock options, the corporation presented two suitable options:

- Estimates of earnings per share that take into account the impact of incorporating options;
- The application of enhanced disclosures.

4.1.8 Intel Corporation

Chips, boards, systems, and software building blocks—the "ingredients" of computers, servers, networking, and communications products—are provided by Intel Corporation (Intel) to the computing and communications sectors. For customers to construct cutting-edge computer and communications systems, these products rely on Intel's technological leadership and proficiency in silicon design and manufacture (www.intel.com/intel/annual01/ about.htm).

The FASB proposal, which would have required taking an earnings charge for employee stock options, was strongly opposed by Intel because it "could potentially undermine the credibility and comparability of corporate financial statements" in the following ways. Intel stated that the FASB proposal "represents both improper accounting and impediment to entrepreneurism and innovation in U.S. high technology industries."

- Since the Black-Scholes method "would not fully address the non-transferability of employee options, their long-term exercisability, or the requirement of continuing employment to exercise the options," it would reduce the accuracy of financial statements.

- The proposed charge is a non-cash item that may never have the value assigned to it and will never be converted to cash. There is no way to undo the charge in the
Exposure Draft "Accounting for Stock-Based Compensation" if the value is never realised.

- Compared to the benefit, the proposed adjustments would involve a lot of implementation work.
- It would have the same effect of economic dilution as already seen in earnings per share.

The company suggests using only annual disclosure which would include the maximum value computed at the grant date of each year in a three year period. Intel claims that due to the lack of a reliable employee stock option valuation method, it would be more "appropriate to disclose a range of possible outcomes in a footnote."

4.1.9 JPMorgan Chase & Co.

A well-known provider of financial services is JPMorgan Chase & Co. (JPMorgan). Its offerings include Treasury and Securities Services, Private Equity and Investment Management, Consumer Banking, Investment Banking, and a number of other services (www.jpmorganchase.com).
According to JPMorgan, the proposed accounting changes in the Exposure Draft "Accounting for Stock-Based Compensation" would not increase the calibre or reliability of financial statements. Employee stock option valuation concerns were the main source of concern for the corporation. The company believed that a disclosure-based approach would be the most appropriate remedy because the pricing techniques utilised for trading options would not result in "a mathematically produced 'theoretical' value which could not be verified by a market transaction."

The business also provided opinions on the following matters:

Measurement Date

JPMorgan backed the suggestion in Exposure Draft "Accounting for Stock-Based Compensation" to calculate compensation costs using the stock price on the award date.

Measurement Method

The fair value is the appropriate measurement attribute for stock awards, according to JPMorgan. The business disagreed with FASB's assertion that "the use of current option-pricing models together with adjustments for forfeit ability and no transferability produce estimates of the fair value of employee options that are sufficiently reliable and relevant to justify recognition in the financial statements."

The following elements, according to the corporation, should be included in the option pricing methodology used to value employee stock options:

- Non-transferability;
- A postponed exercisability because of vesting day;
- Option forfeiture as a result of an employee leaving the company too soon vesting;
- The various borrowing/reinvestment rates that each employee stock option holder must deal with;
- Failure of employees to use dynamic hedging to unlock the time value of options; and
- The premature execution of an option, which often depends on stock price.

JPMorgan believes that all businesses should use the same measurement technique (public and non-public). The business concurred that reducing the value of an employee stock option to reflect its nontransferability is just a random process.

Attribution Period

The corporation agreed that the time between the grant date and the vesting date would be the proper window of time to record the costs associated with employee stock option compensation.


JPMorgan considered disclosures to be the appropriate method of educating users of financial statements. However, the business believed that certain information, such as the anticipated volatility factor and dividend yield, should stay hidden. Complete reliance on estimate-based disclosures may cause consumers of financial statements to understand them incorrectly. It is crucial, in JPMorgan's opinion, that the values of the information provided to those who utilise financial statements outweigh the expense of doing so.

Effective Date and Transition

JPMorgan agreed with the proposed three year pro forma disclosure period before the recognition provision of the Exposure Draft "Accounting for Stock-Based Compensation" are required to be adopted, stating that "A disclosure-based approach is the most appropriate course of action for stock-based compensation."

4.1.10 BankAmerica Corporation

One of the top financial services providers in the globe is BankAmerica Corporation (BankAmerica). BankAmerica provides services to individuals, small enterprises, corporations, and institutions both domestically and abroad (www.bankofamerica.com/investor/).

BankAmerica disagreed with "measuring employee stock options at 'fair value' for both practical and conceptual reasons" and suggested measuring all employee stock options (of public and non-public companies) at their "minimum value." BankAmerica did not support the income statement recognition or the pro forma disclosure provisions of the Exposure Draft "Accounting for Stock-Based Compensation."

In its remarks, BankAmerica addressed the following topics:

Measurement Method

The differences between employee stock options and traded stock options (the nontransferability and forfeitability of employee stock options) could be made up for by adjusting the fair value generated by traded option pricing models, according to Exposure Draft "Accounting for Stock-Based Compensation." Traded option pricing model modifications are difficult to make, according to the business, which said that the FASB proposal "underestimates its complexity."

Mostly due to practical considerations, BankAmerica recommended employing the minimal value method for employee stock option pricing. According to BankAmerica, when using the minimum value approach, "major number of changes would not be required" and "the initial calculation itself is easy, and the variables that come into computation are objective." The fair value technique cannot compare to its precision and accuracy. In comparison to the minimal value calculation, the fair value calculation involves far more judgement and complexity. As a result, the business stated that it would be "more representationally faithful" to evaluate employee stock options at minimum value (and to disclose this as the measurement basis) rather than at fair value.

Measurement Date

The proposal in Exposure Draft "Accounting for Stock-Based Compensation" to calculate compensation costs using the stock price on the award date was endorsed by the corporation.

Attribution Period

According to the Board, the right to retain and exercise the option has already been earned by the time it vests, so the company agreed with FASB that "no compelling rationale exists to prolong the attribution period beyond the vesting date."


The corporation also objected to the Exposure Draft's "Accounting for Stock-Based Compensation" suggestion that an income statement recognition period of four years would follow a three-year disclosure period. BankAmerica Corporation only agreed to the increased disclosures required. FASB should mandate "either disclosure or recognition from the effective date forward, but not one followed by another," the business added.

Effective Date and Transition

In order to provide financial statement preparers time to comprehend and execute the Exposure Draft "Accounting for Stock-Based Compensation," BankAmerica advised delaying the implementation date by at least one year from the time it is finalised.

4.2 Review of Comment Letters Submitted to the ED for SFAS 148

Since it was not possible to review every comment letter that was submitted, we have picked seven businesses and two organisations that provided feedback on the proposed Amendment that eventually led to SFAS 148. When it was feasible, we chose respondents who also wrote comment letters for the SFAS 123 exposure draught. Letter dates are indicated in parenthesis.

The chosen businesses are:

• The Coca-Cola Company (2002)
• The Software & Information Industry Association (2002)
• Anheuser-Busch (2002)
• Accounting and Valuation Group of UBS Warburg Equity Research (2002)
• JPMorgan Chase & Co. (2002)
• SunTrust Banks, Inc. (2002)
• Merrill Lynch & Co. (2002)
• Microsoft Corporation (2002)
• Credit Suisse Group (2002)

We also examine the topics that generated the most debate or concern among responders. Again, unless they were already covered, we give a brief summary of each respondent.

4.2.1 The Coca-Cola Company

As of January 1, 2002, The Coca-Cola Company (Coca-Cola) began using the SFAS 123-proposed fair value method of accounting for stock-based compensation schemes. Coca-Cola was quite interested in the specifications of the proposed statement given the company's choice to make them.

Coca-Cola emphasises the significance of the two new transition techniques described in SFAS 148, which would allow corporations to avoid the ramp-up effect, in its Comment Letter, which supports FASB's recommendation to implement the fair value method.

Upward influence However, the corporation expresses its disagreement regarding where specific necessary disclosures should be placed in financial statements. Coca-Cola believes it would be more appropriate to include such specific disclosures in a separate footnote related solely to stock-based compensation. SFAS 148 requires companies to disclose an extensive amount of information, which should be presented in the "Summary of Significant Accounting Policies."

4.2.2 The Software & Information Industry Association

The main trade organisation for the software and digital content industries is the Software & Information Industry Association (SIIA). For more than 500 top software and information organisations, SIIA offers global services in business development, corporate knowledge, and intellectual property protection. The world`s biggest and most established technology corporations, as well as smaller, more recent businesses, are all members of SIIA (www.siia.net).
In general, SIIA agrees with the criteria for better and more regular disclosure to be made to investors and supports FASB's attempt to revise SFAS 123 and give businesses that choose to adopt the fair value method of accounting for stock-based compensation programmes two more transition alternatives.
The valuation methodologies used to measure employee stock options are the main topic of concern in SIIA's Comment Letter. More freedom and transparency alone won't guarantee give investors better or more insightful information, the SIIA emphasises.

SIIA emphasises the flaws in the Black-Scholes model, which is used to calculate stock option expense. Because the predicted amount is different from what employees will actually realise, SIIA believes that the fair value estimated by option pricing models does not adequately reflect the actual expense. As a result, the financial statements will have exaggerated expenses as a result of valuation utilising modified option pricing models.

The lack of standardisation in valuation procedures is another issue raised by SIIA. Companies will start creating new strategies to determine a fair value of stock-based compensation schemes now that SFAS 123 enables the use of the Black-Scholes model or any other valuation model that incorporates six factors. Investors receive uneven and non-comparable outcomes depending on the valuation model they choose in combination with company-specific computations. Comparing the price of stock options for various businesses with various stock option plans from the perspective of investors and It will be meaningless to compare different Black-Scholes model iterations.

SIIA emphasises its steadfast opinion that the intrinsic value technique is the best way to calculate stock-based compensation expenses since it would give investors the most useful information.

4.2.3 Anheuser-Busch

Anheuser-Busch is a major player in the beer, theme parks, and packaging industries worldwide. Additionally, malt production, rice milling, real estate development, and transportation services are among its areas of interest (www.anheuser-busch.com).

According to Anheuser-Busch, all the information investors require is already accessible in firms' annual reports, and that "stock option accounting is not an issue of either transparency or complete disclosure." Anheuser-Busch believes that the FASB's suggested multiple-choice transition and disclosure strategy is unwise. Multiple adoption options will just confuse investors and have no positive impact on the disclosure's clarity.

Anheuser-Busch advises choosing just one transition technique, the complete restatement technique, as it is the most straightforward. Due to the fact that businesses have been required to submit pro forma disclosures ever since SFAS 123 was introduced, the information required to restate the prior periods is already accessible. Additionally, it equalises the playing field for any businesses that choose to expense stock options.

Anheuser-Busch believes that moving the disclosure of the impact of stock options on the income statement is a form-over-substance measure. The efficacy of disclosure won't be improved by moving this disclosure from the footnotes to the "Summary of Significant Accounting Policies" section. It will be elevated above other disclosures, though, which is unjustified. Users of financial statements, not the location of disclosure within the report, must decide the significance of various disclosures based on their unique investing criteria.

4.2.4 Accounting and Valuation Group of UBS Warburg Equity Research

UBS Warburg Equity Research's (UBS Warburg) Accounting and Valuation Group offers guidance on financial accounting and equity valuation. To stock experts at UBS Warburg Equity Research and to clients of UBS Warburg equities (www.ubswarburg.com).

According to UBS Warburg, FASB's suggestion to allow three transitional techniques would further impede the comparability and consistency of reported results. In addition to identifying whether companies have adopted the fair value based method, users of financial statements will need to know which transition mechanism these companies employed.

According to UBS Warburg, stock options satisfy the requirements for recognition, meaning there is a cost to shareholders when stock options are issued, the cost can be calculated with enough accuracy, and the information is both accurate and relevant in terms of value. So UBS Warburg advises FASB to support the fair value based method of stock option plan accounting. The corporation thinks that the fair value-based approach more accurately depicts economic realities and corporate financial health.

UBS Warburg is in favour of using just one transition strategy. Since it produces consistent and comparable outcomes, retroactive restatement is thought to be the most suitable method. UBS Warburg emphasises that the modified prospective method would be a workable compromise if FASB is unable to implement complete retroactive restatement.

4.2.5 JPMorgan Chase & Co

JPMorgan Chase & Co. (JPMorgan) supports FASB and IASB's efforts to harmonise accounting standards globally. It rejects the majority of the proposed amendment's provisions, nonetheless. JPMorgan recommends continuing to adopt SFAS 123's required prospective method of transition. Although the company is not opposed to the use of the other two alternative methods, it contends that since many businesses that adopted the fair value-based method of accounting for stock-based compensation plans have already done so, others should follow suit in order to guarantee a higher level of comparability going forward.

JPMorgan supports only revealing information in the financial statements' footnotes and not including the expense in the income statement when it comes to disclosure obligations. The firm thinks it would be adequate to demonstrate the pro forma impact of expensing stock options. Additionally, disclosure should appear in the "Summary of Significant Accounting Policies," not the footnotes.

4.2.6 SunTrust Banks, Inc.

One of the biggest commercial banking institutions in the United States is SunTrust Banks, Inc. (SunTrust). Deposit, credit, trust, and investment services are among SunTrust's main lines of business. The business offers services for capital markets, mortgage banking, insurance, and credit cards (www.suntrust.com).

The introduction of two additional transitional accounting methods to businesses who voluntarily chose to use the fair value based method of accounting for stock-based employee compensation programmes, according to SunTrust, will result in inconsistent and non-comparable financial results. It's possible that, for instance, three companies in the same industry with equivalent numbers of outstanding options each may choose for a different transition strategy and report varying levels of stock-based compensation expenditure. The fourth company in the same industry with a comparable number of outstanding options may also decide to use the intrinsic value-based technique of stock option accounting. As a result, the outcomes offered by these businesses would be completely unmatched. SunTrust highlights that unless there is only one standard transition mechanism, increased disclosure won't be helpful in and of itself. The goal of delivering comparable and consistent outcomes in financial statements will be achieved by using the method described in SFAS 123, namely prospective recognition, in combination with additional disclosure requirements.

4.2.7 Merrill Lynch & Co., Inc.

As it will address the issue of comparability of reported results, Merrill Lynch & Co., Inc. (Merrill Lynch) supports FASB's decision to offer corporations two new transition techniques. Merrill Lynch is particularly in favour of keeping up the future transition technique. If it is eliminated, it might deter some businesses from voluntarily switching to the fair value-based form of stock-based compensation accounting.

Merrill Lynch is aware that if three transition methods are permitted, there may be a lack of comparability. According to the corporation, there is inconsistency under the current guidelines and expanding the options for transitioning will barely worsen comparability.

Merrill Lynch also directs FASB's attention to SFAS 123's permitted valuation approach. It raises concerns about the Black-Scholes option pricing model's capacity to sufficiently account for the non-transferability aspect of options and, as a result, appropriately calculate the cost. According to the corporation, FASB should update its guidelines on option pricing models and permit the use of more sophisticated methodologies.

4.2.8 Microsoft Corporation

Microsoft Corporation (Microsoft) is a pioneer in creating, producing, and offering support for software and operating systems (www.microsoft.com).
Microsoft thinks that after adopting the fair value based way of accounting for stock-based compensation expense, there should only be one transition method accessible for the sake of uniformity. The business supports the necessity to provide information about stock options in interim financial statements, but it opposes the idea to include that information in the "Summary of Significant Accounting Policies."

4.2.9 Credit Suisse Group

Leading global provider of financial services, Credit Suisse Group (CSG) counsels clients on all facets of global finance (www.credit-suisse.com).

To ensure consistent expense recognition and, consequently, comparability in the income statements of those companies who opted to implement the fair value technique in SFAS 123, CSG believes that only one transition method should be permitted. According to CSG, FASB should continue using the future transition strategy permitted by SFAS 123. Additionally highlighting the fact that option pricing models fall short of accurately capturing the true economic cost of employee stock options, CSG urges FASB to address this matter in the Exposure Draft.

Quarterly disclosure requirements are excessive, in CSG's opinion. Given that the majority of stock-based compensation awards are given annually, it would not offer valuable information to viewers of financial statements.

4.3 Review of Comment Letters Submitted on IASB Discussion Paper on Share-Based Payments

This section will provide a summary of the Comment Letters concerning the Discussion Paper on Share-Based Payments, which came before ED 2, that were delivered to the IASB. We would like to draw your attention to the fact that ED 2 does not address all of the pertinent concerns, such as whether the measuring date should be the grant date or the vesting date. However, in order to assess whether respondents' opinions actually influenced the standard-setters when publishing ED 2, we decided to take into account the opinions of businesses on these concerns.

We have chosen the comment letters from six corporations and four organisations out of the 311 comment letters that companies and organisations submitted in response to the discussion paper. Letter dates are indicated in parenthesis.

• Ericsson (2001)
• The Swedish Institute of Authorised Public Accountants (FAR) (2000)
• Merrill Lynch (2000)
• The Shell Petroleum Company (2000)
• DaimlerChrysler (2001)
• Association of German Banks (2001)
• Nokia (2001)
• Barclays Bank (2000)
• British Bankers’ Association (2000)
• European Commission (2001)

We tried to choose businesses that were involved in the same industries as those whose comment letters on the exposure draughts of SFAS 123 and SFAS 148 we had already read.

Unless otherwise stated, respondents are described so that the reader is aware of the nature of their business.

4.3.1 Ericsson

One of the biggest manufacturers of mobile systems is Ericsson. It offers comprehensive solutions that address everything from mobile phone systems and applications to services (www.ericsson.com).

According to Ericsson 1, the concern over share-based remuneration is not a top concern for the business as long as U.S. The only expense subject to disclosure under GAAP is share-based remuneration. Since Ericsson is also listed on NASDAQ, it is able to reconcile its Swedish GAAP reporting to U.S. GAAP. GAAP, although the firm adamantly urges IASB "...not to move beyond the U.S. GAAP handling

The business acknowledges that an option pricing model should be utilised to determine the fair value of stock options in the absence of an observable price for such options. Additionally, it states that the assumptions made while using the option pricing model should be disclosed. It is especially pertinent to the employee stock options non-transferability characteristic.

The Discussion Paper suggests an alternative to measuring the fair value of granted options using the vesting date, service date, or grant date. According to Ericsson, the measurement date should be the award date.

4.3.2 The Swedish Institute of Authorized Public Accountants (FAR)

The professional organisation for licenced public accountants, certified public accountants, and other accounting specialists in Sweden is called FAR. The Institute is a key player in the development of the information, education, and professional standards for Sweden's accounting and auditing professionals (www.far.se).
The FAR generally agrees that there is a pressing need for comparable accounting standards to be used globally for the recognition of stock-based compensation expenses because the current disparate handling makes it difficult to compare reported earnings.

FAR believes that the grant of stock options should be recorded in the financial accounts and result in an income statement charge. The appropriate measuring basis is the fair value of the issued options, but only if the fair value can be accurately assessed.

FAR thinks option pricing techniques should be used to determine the fair value of granted options. Option pricing models' underlying assumptions can be changed. But with regard to the adjustments made, full disclosure should be offered. FAR underlines that taking either the negotiated or expected life of the option into account is one of the most crucial decisions made when adopting an option pricing model. The contracted life should be utilised, according to FAR. If not, the explanations for not using it should be made public.

The grant date is, in FAR's view, the most appropriate date for determining the value of stock-based compensation expenditure. The transaction value should be further adjusted over the vesting period if there are more or fewer vesting options than initially anticipated.

4.3.3 Merrill Lynch & Co., Inc.

Merrill Lynch & Co., Inc. (Merrill Lynch) is disappointed that the International Accounting Standard Board (IASB) is revisiting the contentious topic of stock-based compensation expense when, in Merrill Lynch's perspective, the matter has already been discussed and settled in the United States. It highlights that having to value stock options and charge the expense to earnings would be extremely detrimental to both.

Companies those are both well-established and just starting out in sectors where stock awards are a common form of employee compensation.

Merrill Lynch thinks that by releasing SFAS 123, a successful compromise was made in the US. Disclosure regulations helped to attain the required level of transparency. Merrill Lynch believes that the pro forma impact of adopting the fair value based method to calculate stock-based compensation expense offer appropriate information to analysts and investors. As a result, it advises that the IASB proposal should take into account the current procedures that are permitted by SFAS 123.

Merrill Lynch claims that the grant date is the proper date for measuring stock-based transactions in the event that IASB maintains its mandate to use the fair value-based technique. Instead of being charged to income in full at the grant date, the amount recognised should not be spread out throughout the vesting term.

Merrill Lynch is against using option pricing models to calculate stock-based compensation costs because the predicted amount is more than what the employee can really realise. It argues that the financial statements would overestimate the expense if the valuation was done using a modified option pricing methodology.

4.3.4 The Shell Petroleum Company

Leading international energy firm The Shell Petroleum Company (Shell) explores, produces, and refines oil and gas. Additionally, it is involved in renewable energy, with expanding operations in power generation and a wide range of products in the chemicals industries (www.shell.com)

Shell supports the global harmonisation of accounting standards as a multinational corporation. Accordingly, it claims that European companies will be at a greater disadvantage if the Discussion Paper's provisions are not accepted by other standard-setting bodies (and it does not believe that FASB will mandate the mandatory adoption of the fair value-based method of accounting for stock-based compensation expense).

Although Shell acknowledges that an option problem may have an observable value that might be used to replace the value of the services rendered by employees, it also believes that the cost to the business may not always be the same as the economic value to the employee.

The business questions the capacity of option pricing techniques to deliver accurate valuations of granted stock options. Shell concludes by saying
Accrual of stock-based compensation expenditure prior to the establishment of actual option value and economic success could destroy start-up capital and lead to the collapse of viable enterprises.

4.3.5. DaimlerChrysler

One of the top corporations in the world for the automotive, transportation, and service industries is DaimlerChrysler. It makes commercial and passenger automobiles and provides financial and other services (www.daimlerchrysler.com).

DaimlerChrysler generally supports the IASB's suggestion for stock-based compensation accounting. Given stock options should be valued at fair market value and charged to net income. The corporation claims that the final clearance will hinge on whether or not its rivals in the capital markets and in their industry are required to use the same stock-based compensation accounting standards. Different measurement techniques used by businesses in the same industry will only lead to the presentation of false data.

Since the grant date is the date on which all parties agree to the contract and each party's basis for agreement is the market value at the grant date, the grant date would, in the company's opinion, more accurately reflect the value of the stock-based payments. There shouldn't be any adjustments made to the transaction value if the number of shares that actually vest turns out to be either more or less than originally anticipated, as long as these changes don't take place within the vesting period.

4.3.6 Association of German Banks

The private commercial banks in Germany are represented by the Association of German Banks. Small and large banks, international and regional banks are all members of the association (www.german- banks.com).

The proposed accounting for share-based compensation is not accepted by the Association of German Banks. Instead, it suggests delaying the recognition of stock option plans in financial statements until options have been exercised. The issuance of stock options to employees has no impact on the corporation itself; rather, it affects the shareholders alone, which is why stock option programmes are treated in this manner. Employees are not paid in cash as a result, and no real expenses are being recognised.

The recommendations made by the IASB in the Discussion Paper would put all businesses using international accounting standards at a significant disadvantage when compared to businesses who produce their financial statements in line with U.S. GAAP. In addition, it will frequently be hard to determine the fair value of granted options due to the complicated structure of employee stock option plans. The Association views the intrinsic value-based method as the only appropriate and trustworthy way to calculate the cost of stock-based remuneration.

4.3.7 Nokia

In the field of mobile communications, Nokia is the market leader. It is the top provider of mobile phones, fixed wireless networks, and broadband (www.nokia.com).

Nokia vehemently objects to the idea of allocating stock-based compensation costs in accordance with fair market value. According to the corporation, it would be "absolutely unacceptable" for businesses who prepare their financial statements in accordance with IAS to be subject to more onerous regulations than those that do so in accordance with high-quality sets of standards. Therefore, according to the firm, a disclosure strategy similar to that used in the United States would be the only workable answer.

Nokia will give its viewpoint on the key problems, nevertheless, if IASB decides to move forward with the adoption of the fair value-based technique. It thinks that the day stock-based compensation expenditure should be recorded is the grant date. Nokia agrees that when applying option pricing algorithms to estimate employee stock options, they should be changed.

4.3.8 Barclays Bank

One of the biggest financial services organizations in the UK is Barclays Bank (Barclays). With a preference for continental Western Europe, it provides both retail and business banking services inside and outside of the United Kingdom (www.barclays.com).

Barclays acknowledges the need for workers' stock options to be recorded in financial statements. The fair value of the granted options should be used as the measurement basis for such transactions. Barclays believes that using option pricing models is reasonable, but that the presumptions used should be changed to take into account the unique characteristics of employee stock options. To guarantee a uniform treatment, more instructions regarding option pricing models must to be given.

Barclays believes that the grant date should be used as the measuring date since it is at this time that the company values the services that will be rendered. Barclays believes that eventually the transaction amount should be changed to reflect the real number of vested options.

4.3.9 British Bankers’ Association

The major trade organisation in the banking and financial services sector, the British Bankers' Association (BBA), represents banks and other financial services companies in the UK. Both UK and non-UK citizens are members of the association (www.bba.org.uk/public).

BBA acknowledges that there are solid justifications for recording a charge on the income statement for the issuance of employee stock options. However, it claims that there isn't any genuine resource loss for the business. IASB should therefore give additional explanation for why this item should be included in the financial statements rather than just including it as a disclosure in the footnotes.

BBA believes it is questionable to use option pricing methods to estimate stock-based compensation costs. Such models' outputs might have a very individualized value, particularly in marketplaces where there aren't any comparable possibilities.

The use of the vesting date as a measurement date is not one that BBA endorses. The grant date should be used as an alternative. In order to balance the cost and the advantages gained, the transaction charge should therefore be spread out across the service duration.

4.3.10 European Commission

The IASB's efforts to develop an internationally accepted method of accounting for share-based payments have the full support of the European Commission (EC). But it emphasizes the potential impact on many companies' financial statements of the accounting concerns covered in the Discussion Paper. Particularly, it may significantly affect a company's capacity to pay dividends.

The Discussion Paper's main conclusions are not supported by EC. It disputes claims that the corporation incurs expenses as a result of the grant of share options to employees. It is merely an opportunity cost, and the dilution serves as a reflection of that. In actuality, this potential cost is already disclosed as required in the company's reports. Determining whether it is appropriate to recognize opportunity costs in the income statement and, if so, whether they should be limited to shares and options, as well as whether the information currently available about share-based transactions is insufficient for accounts to reflect a true and fair value, are the real issues that should be the subject of discussion, according to EC.

4.4 Review of Comment Letters Submitted on Invitation to Comment “Accounting for Stock-Based Compensation: A Comparison of FASB Statement No.123, Accounting for Stock-Based Compensation and Its Related Interpretations, and IASB Proposed IFRS Share-Based Payment”

By February 1st, 2003, comments were due in response to the invitation to comment entitled "Accounting for Stock-Based Compensation: A Comparison of FASB Statement No. 123, Accounting for Stock-Based Compensation and Its Related Interpretations, and IASB Proposed IFRS Share-Based Payment." We were only able to analyses three of the Comment Letters released by the following organizations and posted on their websites due to time and overall lack of availability of the letters. Their letters' dates are indicated in parenthesis.

• Investor Company Institute (2003)

• Organization for the Biotechnology Industry (2003)

• The Institute of Management Accountants' Financial Reporting Committee and Financial Executives International's Committee on Corporate Reporting (2003)

4.4.1The Investment Company Institute

The national organization for the American investment company sector is the Investment Company Institute (Institute). It was established in 1940 and has 8,935 mutual funds, 559 closed-end funds, and 6 sponsors of unit investment trusts among its members. More than 90 million individual shareholders are represented by its mutual fund members, who also oversee around $6.4 trillion. In terms of legislation, regulation, taxation, public information, economic and policy research, company operations, and statistics, the Investment Company Institute represents its members and their shareholders. The Institute aims to advance fund shareholders' interests, serve the public interest by encouraging adherence to the highest ethical standards by all industry segments, and improve public understanding of the operation of investment companies (www.ici.org/about ici.html).

The Institute advises FASB to continue with a review of SFAS 123. The Institute stated that accounting standards ought to:

(1) demand that issuers treat stock options issued to workers as an expense to be included on the income statement; and

(2) Make that stock options are valued consistently for this reason.

According to the Institute, obligatory expense treatment is required to provide full and equitable disclosure of issuers' financial situation and operating results. The Institute is in favor of the IASB's proposal requiring issuers adhering to IAS to expense the fair value of stock options issued to workers.

The following issues were raised by the Institute:

Issuance, Forfeitures, and Methods of Attribution

The Institute thinks that SFAS 123's approach, which excludes forfeitures from the estimate of the fair value of options granted, is preferable in response to the invitation to comment question about whether the effect of forfeitures should be incorporated into the estimate of the fair value of options granted. Issuers would be able to "manage" the fair value of the options issued and associated compensation expenditure by altering their estimates if the requirement to anticipate future forfeitures and include that estimate into the option pricing model existed. Additionally, it appears that issuers are not permitted to reduce compensation expenditure for any discrepancy between expected and actual forfeitures under the IASB methodology. These factors lead the Institute to consider that the most accurate results come from subtracting the effects of forfeitures from the estimation of the fair value of granted options and adjusting compensation expenditure in accordance with actual forfeitures. The Institute stated that analysts and investors are accustomed to the Statement 123 approach and that the adoption of the IASB approach may make it more difficult for them to predict future earnings and compensation costs (www.ici.org/02 fasb stock option.html).

4.4.2 The Biotechnology Industry Organization

More than 1,100 biotechnology businesses, academic institutions, state biotechnology centers, and allied organizations are represented in all 50 U.S. states by the Biotechnology Industry Organization (BIO), a national trade association for the biotechnology industry. Employee stock option programmes are crucial to the biotechnology sector's continued expansion, just like they are in many other economic growth areas.
These strategies are crucial now more than ever as the sector continues to commercialize its goods and seeks to hire workers from other, more established sectors (www.bio.org/tax/letters/20030131.asp).

The Invitation to Comment's usage of the Black- Scholes Value for employee stock options is BIO's main point of contention. The biotechnology sector (as well as the membership of BIO) is dominated by rising growth businesses, many of which have stocks that are very volatile and have little liquidity. Because of this, BIO opposes the income statement expenditure reporting of stock options. The Black-Scholes model, in particular, was not intended for and is improper for evaluating employee stock options. The algorithm generates values for volatile equities that, in its opinion, mislead investors and other consumers of financial statements. Additionally, the Black-Scholes model ignores the fact that employee stock options are sometimes ineligible for exercise due to blackout periods and are not openly traded. BIO is still of the opinion that the SFAS 123 reporting options currently available are effective and ought to be maintained. According to them, it would be their pleasure to give investors various examples of how the Black-Scholes Value, when used in relation to businesses in their field, can be seriously deceptive.

BIO offered its viewpoint on the following topics:

Models for Pricing Options and Valuing Employee Stock Options

The adoption of an adequate option-pricing model for footnote disclosure should be mandated by the accounting standard. The model employed, together with important assumptions and the rationale for choosing a specific model, should be made explicit in the footnotes. For businesses with very volatile or illiquid stock prices, the Black-Scholes model frequently yields false conclusions. The volatility assumption is only given limited quality guidance in the present version of SFAS 123, and value adjustments for companies with sparsely traded equities are not taken into account. In order to determine fair value more precisely, adjustments must be made for these considerations. Employee stock options also lose value because they are non-transferable and subject to forfeiture. Existing models do not take these elements into account, which causes an overestimation of value. Additionally, according to BIO, the standard should allow for the introduction of fresh, suitable option-pricing models as they emerge.

Issuance, Forfeitures, and Methods of Attribution

The method of submitting estimates for forfeitures at the time of award, which eliminates significant revisions that may take place under current U.S. law, is one that BIO believes has merit.

Standards, as a similar strategy may lead to inflated compensation costs for startups and businesses experiencing significant unplanned force reductions.

The current attribution approach in SFAS 123, in the opinion of BIO, is the mechanism that best captures the economics of stock-based compensation agreements. The "unit-of-service" idea in the proposed IASB rule, according to BIO, is unnecessarily complicated, will be challenging to track, and won't produce estimates that are more precise than the straight-line or graded vesting approaches under SFAS123.


BIO is still in favour of enhanced disclosures that are useful to investors and those who read financial statements. The current worry is that the disclosure of stock options may grow to be overly lengthy and intricate for investors and other users of financial statements. Therefore, BIO concurs with the IASB's recommendation to offer more disclosure regarding important assumptions (volatility and vesting conditions).

4.4.3 The Committee on Corporate Reporting of Financial Executives International and the Financial Reporting Committee of the Institute of Management Accountants

In response to the invitation to comment "Accounting for Stock-Based Compensation: A Comparison of FASB Statement No.123, Accounting for Stock-Based Compensation and Its Related Interpretations, and IASB Proposed IFRS Share-Based Payment," the Financial Executives International Committee on Corporate Reporting and the Institute of Management Accountants' Financial Reporting Committee (the Committees) expressed their views. (See www.fei.org/download/FEI IMA FAS123.pdf.)

The Committees expressed their views on the following issues:

Issuance, Forfeitures, and Attribution Methods

The Committees concur with the FASB's finding that an equity instrument is only issued after receiving valuable consideration. Employee stock options are distinct from almost any other equity instrument due to vesting limits and the possibility of forfeiture, which supports the viewpoint presented in SFAS 123. As a result, the Committees disagree with the units of service model suggested in the IASB ED. The conceptual underpinning of the IASB attribution model, in the Committees' opinion, is incoherent since it is not relevant to recognize an expense for options that never vest, as the IASB mandates. The Committees are also worried that costs recognized using the units of service approach would potentially be higher than the fair value of granted options. The entire model's trustworthiness is strained by these results. The Committees feel that the IASB model's guiding principles should only be used if they are clearly superior to SFAS 123.

Option Pricing Models/Valuation of Employee Stock Options

The Committees claim that there is unanimity among the members of both Committees that employee stock options are significantly overvalued under traditional option pricing models, and that modifications are required to reflect these discrepancies. The changes included in SFAS 123, it is widely agreed, do not sufficiently represent those disparities. Furthermore, since the publication of SFAS 123, there hasn't been much progress in the creation of a solid valuation model for employee stock options that would serve as a solid foundation for a prescriptive measurement strategy. The Committees observe that the majority of accounting standards only offer high-level guidance on fair value measurement. The Committees feel that it would be inappropriate to offer very prescriptive guidance in this area given the lack of a sound valuation theory for figuring out the fair value of employee stock options. If expense recognition for employee stock options is ultimately necessary in financial statements, the obligation should end at the principles level by stating that fair value should be used for measurement. Companies should be allowed to utilise professional judgement in determining their best estimate of each relevant variable in accordance with the fair value goal without FASB and IASB mandating the use of a specific option pricing model. If necessary, the standard could list many aspects to take into account when calculating fair value, such as:

• The option's exercise cost

• The underlying security's current price.

• The estimated life of the options, or the time frame during which they will actually be exercisable

• The projected risk-free interest rate for the time frame corresponding to the anticipated option term

• The underlying security's anticipated future volatility

• Dividends anticipated

• The impact of the options' non-transferability on their value

• The impact on value if there is a blackout period after the option is exercised and the stock cannot be sold.

When finding an appropriate fair value, the accuracy of the assumptions employed in option pricing models is crucial.

The Committees asked valuation experts for their opinions on the factors that ought to serve as the foundation for a fair value criterion, and they were told that in order to determine fair value, businesses should be able to:

• Rather to relying solely on an option's expected value, consider using the lifetime probability distribution calculated from past data;

• use a stochastic model for volatility that has been adjusted using data from the past;

• Use models other than the typical geometric Brownian motion to characterize the uncertainty in the temporal evolution of share prices into the future, assuming that such models are supported by actual data.

The Committees concur that it would be acceptable to disclose information that would aid investors in understanding the model that was employed and the methodology utilized for calculating the assumptions if such revisions were authorized.

4.5 Overview of Company Reporting Practices

To investigate their stock-based compensation accounting practices, we have picked ten companies. We compare the opinions people express in the Comment Letters to their actual behavior. Every business we are covering is a response under one of the Comment Letters categories. We do not include all of the companies because eleven of them are organizations (such as The Boston Security Analysts Society and The Software & Information Industry Association) that represent the opinions of their members but do not themselves engage in stock-based compensation accounting; one company (LTV Steel) went bankrupt between 1993 and 2003; or two companies merged (The Chase Manhattan Corporation and JPMorgan). We are examining the most recent annual reports of the companies that are available.

4.5.1 The Shell Petroleum Company

The goal of group managing director compensation at Shell Petroleum Company (Shell) is to draw in and keep highly skilled workers while inspiring them to provide excellent work. Therefore, the remuneration systems are created to balance the objectives of senior staff with those of the business and shareholders. A large amount of compensation packages are based in part on real performance.

A method of long-term incentives is the use of group stock option plans. In accordance with one of the Group Stock Option Plans, Shell issues stock options once a year. Executives have received ten-year stock options from Shell since 1998. 50% of the options are subject to various performance requirements, and the vesting period is typically three years long.

The shares granted through group stock option plans are existing issued shares of the firm, according to Shell's Annual Report for 2001. Therefore, there isn't any equity dilution among stockholders. The exercise price, which determines the price at which shares may be purchased, may not be less than the fair market value of the shares as of the grant date.

The stock option expenditure is not disclosed by Shell in its income statement. According to Dutch GAAP, the Group Consolidated Financial Statements are created. In their Comment Letter, Shell argued that forcing European businesses to cost employee stock options will disadvantage them more as long as the requirement is not made universal. Under Dutch GAAP, there is no duty to disclose stock-based compensation expenditure measured at fair value, hence the corporation simply makes this disclosure in the financial statements' footnotes. However, in our judgement, the corporation is losing out on some opportunities. A total of 16,000 EUR worth of options were exercised in 2001. The market price at the time of exercise was 67.26 EUR, whereas the exercise price was 48.92 EUR.

The Shell subsidiary's financial statements are prepared in the US in accordance with US GAAP. However, the corporation does not account for stock-based compensation expense using the fair value based technique. It simply offers the disclosure that SFAS 123 mandates. The pro forma impact on net income and earnings per share determined in accordance with SFAS 123 criteria is simply stated in the notes to the financial statements as not material. The company's mistrust of current stock price models may possibly be the cause of Shell's hesitation to report employee stock-based compensation expense.

4.5.2 Anheuser-Busch

According to US GAAP, Anheuser-Busch prepares its financial statements. The corporation opposes the idea of include employee stock-based compensation expense in the income statement in its Comment Letter since the notes to the financial statements already contain all the required information. Following this declaration, the company states that it accounts for employee stock option expense in accordance with APB 25 in the "Summary of the Significant Accounting Principles and Policies" of the annual report for the year 2001. Under this statement, the company does not record any expense related to employee stock options in the income statement as options are always granted at a price equal to the market price on the grant date.

In accordance with the requirements of SFAS 123, the company provides pro forma effects that the stock options would have on the income statement had the employee stock-based compensation expense been recorded using the fair value based method in Note 5 to the financial statements of the annual report for 2001. The reported net income discrepancies are rather large. While the corporation recorded stock-based compensation expenditure utilising the fair value based technique, net income would have been 1,635 million USD instead of 1,704 million USD under APB 25. Anheuser-Busch utilises the adapted Black-Scholes option pricing model to determine the fair value of granted options. The corporation underlines that it used the Black-Scholes model to determine the weighted average fair value of stock options issued for SFAS 123 disclosure purposes. However, in practise, employees cannot benefit from owning these plans until there is a gain in the market price of Anheuser-Busch shares, as the company's employee stock options are not traded on an exchange.

4.5.3 SunTrust Banks, Inc.

Financial statements for SunTrust Banks, Inc. (SunTrust) are made in line with US GAAP. Employee stock-based compensation costs are accounted for in accordance with APB 25, meaning the corporation does not record compensation cost while accounting for its stock option schemes. SunTrust discloses the pro forma effects of utilising the fair value based method to account for stock-based compensation expense as required by SFAS 123 in the notes to the financial statements. The amount of SunTrust's reported income in 2000 was USD 1,294 million. A pro forma net income of $1,281 million USD would be generated. The Black-Scholes option pricing model was updated to determine the weighted average value of the granted options.

4.5.4 Nokia

Finnish Accounting Standards are followed in the preparation of Nokia Group's financial statements. Nokia vehemently opposed the idea of incorporating employee stock-based compensation expense in the income statement in its Comment Letter. As a result, Nokia offers thorough disclosure regarding the issued stock option plans in its Annual Report 2001, which is included in the notes to the financial statements. It lists the quantity of stock options that have been awarded, how the corporation divides those options into different categories, how much stock options cost to subscribe for, and how many stock options have been granted, exercised, and forfeited. However, the firm does not disclose any pro forma effects that the stock option plans may have on the company's financial statements if they were valued at fair value and included as an expense in the income statement.

4.5.5 UBS Warburg Group

Financial statements for the UBS Warburg Group are prepared in conformity with international accounting standards (IAS). Due to the fact that UBS Warburg is also listed in the US, it details all material variations that would occur if the annual reports were prepared in line with US GAAP in the notes to the financial statements.

Despite supporting the proposal to measure employee stock-based compensation expenses at fair value in the Comment Letter, UBS Warburg tracks stock-based compensation expenses under IAS using the intrinsic value-based method. The corporation gives a thorough disclosure of the share-based compensation plans available to employees in the 2001 annual report's notes to financial statements. Included in the data are the total numbers of stock option plans granted as well as the weighted average purchase price. As was already indicated, the corporation highlights the key differences that would occur if the financial statements were prepared in accordance with US GAAP. Additionally, UBS Warburg provides the pro forma net income and profits per share as if the business had chosen to account for stock-based compensation expenditure using the fair value based method.

4.5.6 The Coca-Cola Company

The Coca-Cola Company (Coca-Cola) vehemently rejected the Exposure Draft "Accounting for Stock-Based Compensation" in 1993, citing the lack of a trustworthy and impartial approach for the assessment of compensation costs as the primary justification. Ten years later, however, Coca-Cola is one of the first businesses to begin depreciating employee stock-based compensation programmes using the fair value method.

According to US GAAP, the corporation creates its financial statements. According to the company's disclosure in Note 12 "Restricted Stock, Stock Options and Other Stock Plans" of its 2001 annual report, Coca-Cola accounts for employee stock-based compensation in accordance with Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees," and related Interpretations. As a result, the company does not include any expense for employee stock options in its income statement.

Coca-Cola presents the pro forma effects that employee stock options would have on the income statement if the business had chosen to measure stock-based compensation costs using the fair value based methodology. The major discrepancy between reported net income and net income after the impact of applying SFAS 123 was $0.202 million USD as of December 31, 2001. While the corporation recorded stock-based compensation expenditure utilizing the fair value based technique, net income would have been 3,767 million USD instead of 3,969 million USD under APB 25.

Coca-Cola said in July 2002 that it would begin depreciating the cost of all stock options given by the business in the fourth quarter of 2002. Our management's decision to switch to the preferred method of accounting for employee stock options ensures that our earnings will more accurately reflect economic reality when all compensation costs are recorded in the financial statements, according to Doug Daft, chairman and chief executive officer (http://www2.coca-cola.com/presscenter/nr 20020714 atlanta_ stock_ options.html).

The corporation made the choice to use SFAS 123's fair value-based approach of documenting stock options, which is thought to be the best accounting practice for stock-based employee pay. Based on the fair value at the time the options are granted, all upcoming employee stock option grants will be expensed over the stock option vesting period. The implementation of this accounting approach is anticipated to have a negligible financial impact on the company's results in the current year. The projected impact for 2002 would be roughly $0.01 per share if the Board of Directors awards options at a level similar to that of 2001.

Coca-Cola emphasizes that putting all types of options on an equal accounting footing eliminates any potential bias toward issuing the types that do not need to be expensed, which is a significant benefit of the expensing strategy the business is implementing. With this new policy, the company will have the freedom to create the options that it thinks will best inspire employees and more closely connect their interests with those of stockholders. This will be done without taking into account how the options will affect the company's accounting. The policy also equalizes options with other forms of pay, enabling the business to create compensation plans that make the most sense possible (http://www2.coca-cola.com/presscenter/nr 20020714 atlanta stock options.html).

4.5.7 Merrill Lynch & Co., Inc.

The majority of businesses, including Merrill Lynch & Co., Inc. (Merrill Lynch), opposed the Exposure Draft "Accounting for Stock-Based Compensation" in 1993, and Merrill Lynch continues to oppose the fair value-based method of accounting for employee stock-based compensation schemes. According to the corporation, there is no impartial way to calculate the fair value of employee stock options.

Instead of using the fair value-based method in SFAS 123, Merrill Lynch accounts for employee stock-based remuneration in accordance with the intrinsic value-based method in APB 25. Merrill Lynch grants stock options having no intrinsic value, hence no compensation expenditure for stock options is recorded. Over the course of the vesting period, compensation expense associated with other stock-based compensation programmes is recorded. On the consolidated balance sheets, the unamortized component of employee stock awards made under such schemes is shown as a reduction to stockholders' equity under the heading unamortized employee stock grants.

Option grant-related pro forma compensation expenditure is recorded over the vesting period. Merrill Lynch reports the 854 million US $ discrepancy between reported net earnings (loss) and net earnings (loss) after implementing SFAS 123. While the corporation recorded stock-based compensation expenditure utilizing the fair value based technique, net earnings (loss) would have been (281) million USD instead of 573 million USD under APB 25.

4.5.8 Intel Corporation

The Exposure Draft "Accounting for Stock-Based Compensation" was contested by Intel Corporation in 1993. The alternative fair value accounting required by SFAS 123 requires the use of option valuation models that were not created for use in valuing employee stock options, so the company continues to disagree with the suggestion to expense the employee stock-based compensation plans and adheres to APB 25 in the accounting for its employee stock options. According to APB 25, no compensation expense is recorded in the firm's financial statements because the exercise price of the employee stock options granted by the company is equal to the market price of the underlying stock on the day of grant.

SFAS 123 stipulates that the corporation must provide pro forma data as if it had accounted for its employee stock options using the fair value approach. In order to give information on the fair value of options awarded in 2001, the corporation used the Black-Scholes option pricing model to estimate the value of employee stock options at the time of grant.

The estimated fair value of the options is charged to expenditure over the options' vesting periods in order to comply with pro forma disclosure requirements. The reported net income for the year 2001 was $1,291 million, however the net income after applying SFAS 123 was 254 million dollars.

The Black-Scholes option valuation model was created, emphasises Intel Corporation, to be used in determining the fair value of traded options that are completely transferable and do not have any vesting restrictions. Additionally, very arbitrary assumptions, such as the anticipated stock price volatility, must be entered into option valuation models. The existing models do not necessarily provide a reliable single measure of the fair value of employee stock options because the company's employee stock options have characteristics that are significantly different from those of traded options and because changes in the subjective input assumptions can materially affect the fair value estimate, in the opinion of management.

4.5.9 JPMorgan Chase & Co

The Exposure Draft "Accounting for Stock-Based Compensation" was challenged by JPMorgan Chase & Co. in 1993 because it didn't enhance the reliability and quality of financial statements. But as of January 2003, the corporation began depreciating employee stock options.

According to APB 25, JPMorgan Chase accounts for its employee stock-based compensation schemes using the intrinsic value-based technique. Since stock options have no intrinsic value on the grant date, no expense is recorded for them. The corporation gives the pro forma effects that the stock options would have on the income statement in accordance with SFAS 123 (www.ar.jpmorganchase.com/ar2001/audited/n19.html). Employee stock-based compensation expense is reported utilising the fair value based method.

According to JPMorgan Chase, options would have been valued using the Black- Scholes model if the corporation had implemented the fair value based technique in accordance with SFAS 123. Applying SFAS 123 had a greater impact in 2001 due to the lower net income level and more alternatives offered during that year. The substantial difference between net income as reported and net income after the impact of adopting SFAS 123 was $0.622 billion USD. While the corporation recorded stock-based compensation expenditure utilising the fair value based technique, net income would have been 1,072 million USD instead of 1,694 million USD under APB 25. According to JPMorgan Chase, it valued the options issued as part of equity awards using the Black-Scholes model utilising weighted-average grant-date fair value and assumptions.

According to a JPMorgan Chase announcement, the business would begin depreciating all stock options awarded to workers in January 2003. JPMorgan Chase is one of the rare organizations that offers an options programme to practically all employees, hence the company will be impacted more than some other businesses. (JPMc/about/facts/ceo email; www.jpmorganchase.com/cm/cs?pagename=phase/ Href).

4.5.10 BankAmerica Corporation

The Exposure Draft "Accounting for Stock-Based Compensation" was not supported by BankAmerica Corporation (BankAmerica) in 1993. The corporation still refuses to expense employee stock options and accounts for its employee stock option schemes in accordance with APB 25's guidelines. According to SFAS 123, the company discloses information as if it had started using the fair value-based technique to calculate the value of outstanding employee stock options in 2001. The major discrepancy between reported net income and net income after the impact of applying SFAS 123 was $0.351 million USD as of December 31, 2001. According to APB 25, net income was $6,792 million USD, whereas $6,441 million USD would have been earned had the company recorded stock-based compensation expense using the fair value-based method (www.s1.mobular.net/ccbn/7/27/29/).

The corporation employed weighted-average grant-date fair value and assumptions to value the options using the Black-Scholes option pricing model in order to estimate the fair value of awarded employee stock options on the grant date. The fair value based method allocates compensation expenditure across the employee stock option vesting term.

BankAmerica emphasized that the Black-Scholes option pricing model was created to estimate the fair value of traded options, which differ from employee stock options in that they have different characteristics, and that changes to the model's subjective underlying assumptions can lead to materially different fair value estimates.

5 Analysis

We examine the findings of our examination of the numerous Comment Letters reported in Chapter 4 in this chapter. To more effectively condense the substantial body of empirical evidence, we offer the analysis under the following subheadings in Section 5.1: SFAS 123, SFAS 148, IASB Discussion Paper, and Invitation to Comment. We also provide an overview of key concepts and methods that are relevant to how businesses actually operate, as found in their annual reports and numerous press releases.

5.1 General

The widespread usage of stock options as a form of employee remuneration has a variety of well-founded reasons, despite the fact that not everyone agrees that employee stock-based compensation programmes have a favourable impact on businesses. It is said that stock options balance the interests of owners and employees. They make it easier to create jobs, particularly in the information technology sector, and they support businesses in navigating competitive labour markets. Due to the fact that such programmes do not result in actual cash outflows from the company, companies view stock options as a more effective method of compensating employees. A corporation may improve its performance by coordinating the interests of its two main stakeholder groups, its shareholders and employees. However, it appears that there are just as many people opposed to stock options as supporters. The widespread usage of stock options is thought to have the potential to considerably raise the company's shareholder value over time. However, other stakeholders may have an unfavourable opinion of issuing stock options if the company is performing worse than other companies in the industry.

Exposure Draft 2 was released by IASB and SFAS 123 was introduced by FASB in a natural flow of events. Despite the fact that stock option plans are becoming popular, there is no set method for accounting for them. In Europe, a standard actually doesn't exist at all (Levinsohn, 2002). When the FASB released its Exposure Draft in 1993, it made an effort to recommend an accounting approach based on fair value. Strong lobbying, however, prevented this measure from passing. Businesses saw it as a danger to the positive results shown in their financial statements. The fair value based method and the deduction of stock option compensation expenditure from income are widely opposed by the business community. Our belief is that their hesitation to use the fair value based method stems mostly from their worry that lower earnings will have a negative impact on the share price.

The problem was initially addressed by IASB when it released a Discussion Paper on Share-Based Payments in 2000. Its suggestion that share-based compensation expenses be calculated at fair value was not well embraced in Europe either. Companies are free to exclude the disclosure of any expenses associated with stock options due to the lack of regulations requiring the adoption of the fair value based method of accounting for stock-based remuneration. This is the case, for instance, with Shell, which claims that the differences between the intrinsic value and fair value are negligible but does not disclose any pro forma implications of applying the fair value based method.

5.2 Opinions on Stock-Based Compensation

5.2.1 SFAS 123

Ten comment letters on the FASB Exposure Draft "Accounting for Stock-Based Compensation" from 1993 have been examined. Nine Comment Letters, or a sizable majority, were against the Exposure Draft. Only one corporation, in its Comment Letter, endorsed the FASB Proposal in its entirety. Other businesses claimed that the proposed accounting rules would result in a result that is less significant to the readers of financial statements than the current rules and would not improve the overall usefulness and trustworthiness of the financial statements. It was claimed that the proposed standards in the Exposure Draft would make corporate financial reporting unclear, inconsistent, and inaccurate and would lessen the comparability of financial statements. In comparison to the benefit, the suggested improvements would be difficult to implement.

The following were the primary issues that were in essentially every Comment Letter we looked at:

Measurement Date

The Exposure Draft position that the stock price at the grant date should be used to measure compensation cost was backed by the majority of the firms.

Measurement Method

Due to the lack of an accurate and impartial assessment method, the majority of businesses opposed the fair value-based method and disagreed with the recognition of compensation expense. Due to significant differences between traded options and non-traded employee stock options, such as no transferability, forfeitability of employee stock options, their long-term exercisability, the need for continued employment to exercise the options, and future stock values, existing option pricing models are quite subjective and do not produce a reasonable or relevant value for employee stock options. Volatility in price, variations in vesting timelines, and price movements that are unrelated to corporate success.

For the purpose of valuing employee stock options, some businesses recommended utilising the minimum value method. This approach might significantly cut down on adjustments. The fair value technique cannot compare to its precision and accuracy. In comparison to the minimal value calculation, the fair value calculation involves far more judgement and complexity.

Attribution Period

The companies agreed that the time between the grant date and the vesting date would be the proper window of time to recognise the costs associated with employee stock option compensation.


The consensus among all the companies under study was that transparency might be a better option than recognising compensation expenses. They held that disclosures were the appropriate means of educating users of financial statements.

5.2.2 SFAS 148

The FASB made another effort to get businesses to use the fair value-based method of accounting for stock-based compensation expense by introducing SFAS 148. Companies are anticipated to benefit from the two new transition procedures described in SFAS 148 as they shift from the intrinsic to the fair value based accounting approach. However, after reading the comment letters, we understood that adding two more options for transition did not actually make the matter clearer. Six out of the nine companies who’s Comment Letters we analysed expressed worry about having a variety of transition options. They think it will just make it more difficult to compare financial results. The majority of respondents agree that only one transition technique should be used, typically the complete restatement method because all essential data is already available.

It seemed that different businesses have diverse viewpoints on the use of two new transition techniques. On the one hand, some of them see it as a way to increase the stated outcomes' comparability and transparency. On the other side, some of the responding companies argued that providing investors with a variety of transition options would simply increase investor confusion and harm comparability. Another argument made in the Comment Letters was that the comparability is already severely compromised and that having three options for transition procedures won't do any harm. Three different transitional options, though, may encourage more businesses to use the fair value approach.

None of the responding corporations agreed with FASB's suggestion to include the disclosure of stock-based compensation expense in the "Summary of Significant Accounting Policies." The consensus expressed in the comment letters was that transparency should be included in the financial statements' footnotes. One of the justifications cited was that including this disclosure in the "Summary of Significant Accounting Policies" will elevate it above other unjustified disclosures. Which disclosure should take precedence should be up to the users of financial statements to determine. It appears that while firms are working hard to hide this disclosure, FASB is making an effort to draw readers of financial statements' attention to it.

5.2.3 IASB Discussion Paper on Share-Based Payments

The following were the primary issues that were in essentially every Comment Letter we looked at:

• Choosing between the intrinsic and fair value methods to calculate stock-based compensation costs,
• How fair value should be calculated, if it is to be used;
• The most suitable date for the measurement.

The majority of businesses emphasise the demand for a unified accounting standard that addresses the reporting of stock-based compensation expenses. They are against the IASB's proposal to deduct stock-based compensation expenditure from income unless stock options are given the same treatment abroad, especially in the US. If this was mandated for all businesses in the major global markets, it appears that certain European businesses would be more inclined to use the fair value-based accounting technique for stock options. However, Merrill Lynch claims that the compromise reached in the United States is actually rather successful. As a result, it suggests that IASB consider stock option expense the same way.

There is no consensus on this topic in practise, just as there is no understandable theoretical framework for defining whether employee stock options are an expense for corporations or not. Companies that disagree with the fair value-based approach of accounting generally give the same justification: stock options solely effect shareholders and do not result in a cash outflow for the company.

In our opinion, if there were accurate ways to measure this worth, more organisations would prefer the fair value-based approach. All of the companies that responded noted the lack of a reliable method to determine the fair value of the awarded stock options. It appears that no corporation is happy with the option pricing methods that are currently in place. They believe they are improper for employee stock option valuation. It is frequently emphasised that when using the Black-Scholes and binominal option pricing models to analyse employee stock options, the assumptions utilised must be adjusted. The changes would be somewhat arbitrary and company-specific. As a result, the final outcomes would be incomparable amongst companies. It would be more clear how corporations determined stock option costs if they disclosed the assumptions they used when utilising option pricing models. The need to introduce updated, more understandable, and employee stock option-specific models to calculate stock-based compensation expense, however, persists despite even thorough disclosure.

All responding companies concurred that the grant date is the most appropriate date to measure stock-based compensation expense since it is the day on which all parties to the transaction agree on the transaction's terms and value.

5.2.4 Invitation to Comment

The following were the primary issues that were in essentially every Comment Letter we looked at:

Issuance, Forfeitures, and Methods of Attribution

Because the conceptual underpinning of the IASB attribution model was inconsistent, some businesses disagreed with the units of service model suggested in the IASB ED. The risk that expenses recognised using the units of service technique may in fact be greater than the fair value of granted options has also been a source of worry. The entire model's trustworthiness is strained by these results.

Companies considered that Statement 123's approach, which excludes forfeitures from the assessment of the fair value of options granted, is the preferable one in response to the question of whether the effect of forfeitures should be integrated into the calculation of the fair value of options granted. Issuers would be able to "manage" the fair value of the options issued and associated compensation expenditure by altering their estimates if the requirement to anticipate future forfeitures and include that estimate into the option pricing model existed. Furthermore, issuers would not be able to modify compensation expense for any discrepancy between estimated and actual forfeitures under the IASB approach. Furthermore, the new IFRS will not produce estimates that are more accurate than the straight-line or graded vested procedures under Statement 123 and is unnecessarily complex, making it challenging to track.
Option Pricing Models / Valuation of Employee Stock Options

The adoption of an adequate option-pricing model for footnote disclosure should be mandated by the accounting standard. The model employed, together with important assumptions and the rationale for choosing a specific model, should be made explicit in the footnotes. For businesses with very volatile or illiquid stock prices, the Black-Scholes model frequently yields false conclusions. According to SFAS 123, there isn't much good advice for figuring out the volatility assumption, and it doesn't take into account value adjustments for businesses with thinly traded stocks. In order to determine fair value more precisely, adjustments must be made for these considerations. Employee stock options lose value since they are non-transferable and subject to forfeiture. Existing models do not take these elements into account, which causes an overestimation of value.

Businesses stressed that FASB and IASB shouldn't require the use of a specific option pricing model and that businesses should be allowed to apply professional judgement in determining their best estimate of each relevant variable in accordance with the fair value goal.

Companies recommended using a stochastic volatility model calibrated to historical data, using the probability distribution of an option's lifetime rather than just its expected value to determine fair value, and using models other than the standard geometric Brownian motion to describe the uncertainty in the temporal evolution of share prices into the future, provided empirical evidence can support these suggestions.

The firms concur that it would be acceptable to disclose information that would aid investors in understanding the model that was utilised and the methodology used for generating the assumptions if such revisions were authorised.


Companies stated that they believed enhanced disclosures would benefit both shareholders and those who read financial statements. The current worry is that the disclosure of stock options may grow to be overly lengthy and intricate for investors and other users of financial statements. Some businesses agreed with the IASB's recommendation to disclose extra information about important assumptions (volatility and vesting conditions).

5.2.5 Practice of Accounting for Stock-Based Compensation Expense

The vast majority of corporations utilise the intrinsic value-based method to quantify stock-based compensation expenditure, according to our analysis of annual filings from companies. The actions of two companies go against the viewpoints in their Comment Letter. For instance, UBS Warburg Group completely concurred in its Comment Letter that stock options satisfy all requirements for expenditure recognition and should, thus, be deducted from income. The business suggests that FASB support making the use of the fair value-based method mandatory. It would be reasonable to believe that UBS Warburg Group values employee stock options using a fair value-based methodology. However, when we examined the company's financial reports, we discovered that it only gives pro forma results of applying the fair value based assessment and applies the intrinsic value based technique. The Coca-Cola Company fought against the Exposure Draft SFAS 123 in 1993. However, it was among the first businesses to begin writing off employee stock options.

Companies don't seem keen to embrace the fair value based strategy, despite the efforts made by FASB in the United States to urge them to do so. However, a large number of businesses, including Coca-Cola, American Express, Bank of America, Computer Associates, Washington Post, Amazon.com, and many more, have voluntarily chosen to expense stock options (www.fed.org/onlinemag/sep02/trends.htm). It may be notable that the majority of the businesses that have made their decision to expense stock options publically do not belong to those with larger, more comprehensive, and widespread stock option programmes. So, for them, choosing to spend is substantially less expensive. Companies with very sizable and widespread stock option programmes, on the other hand, have indicated a choice to stick with current policy (not to expense options).

In Europe, where there is currently no established standard for accounting for stock-based remuneration, adoption of the fair value based method is much less likely to spread (Levinsohn, 2002). The most popular approach is to merely disclose the pro forma impacts of using the method based on fair value. It appears that businesses believe it to be adequate. The level of disclosure varies from business to business. According to APB 25, American businesses must declare their pro forma income statements and earnings per share. The European businesses we looked at typically only disclose broad details on the stock option schemes they provide, such as the total number of stock options issued, exercised, and forfeited.

The number of businesses deducting or preparing to deduct employee stock option costs has quietly climbed. Only two of the corporations we analysed, JP Morgan Chase and the Coca-Cola Company, began deducting the cost of employee stock options.

The Coca-Cola Company claimed that ensuring the most accurate financial reporting was the primary driver behind this decision. Coca-Cola came to the conclusion that when those expenditures were accounted for in their financial statements, the company's earnings would more accurately represent economic reality.
The Coca-Cola Company claims that one of the challenges businesses had when switching to the fair value based system was figuring out the precise amount that needed to be recorded as an expense. Companies must establish the "fair value" of stock-based remuneration in accordance with FASB regulations. No specific model is required, despite the fact that six important factors are recognised (stock price, exercise price, risk-free interest rate, estimated duration of the option, expected stock price volatility, and projected dividends).

The benefit it offers to investors—a better portrayal of the company's economic reality (an improvement in investors' confidence in corporations)—and more comparability among companies with stock option programmes are its key benefits of expensing stock options. These advantages might make it easier for businesses to create the types of options they think will best inspire workers and more closely match their interests with those of stockholders, regardless of the accounting impact of those options.

6 Concluding Discussion

What is the corporate community's position on expensing stock-based compensation plans and what arguments are offered for and against? That is the question that this chapter seeks to address. It also summarises the evidence gathered.

6.1 Conclusions

As we stated earlier in this thesis, the topic of stock-based compensation expense measurement and recognition in the income statement has been under discussion for many years by a variety of interested parties, including the business community, which includes companies, investors, accountants, and professional associations, as well as the IASB and FASB. In order to determine what the current FASB standards require, what the IASB intended when it released Exposure Draft 2, and what the opinions of business enterprises are regarding the current and proposed standards, we concentrated our attention on the FASB and IASB's existing and proposed standards as well as the Comment Letters of various companies and organisations. Additionally, we investigated how businesses actually handle employee stock option expense recognition.

We discovered that most businesses oppose the idea of recognising employee stock-based compensation programmes as an expense on the income statement after examining Comment Letters and corporations' viewpoints on the matter. They offer several justifications for this stance, which we sum up as follows:

• Giving staff stock options doesn't actually cost the business any money. This remuneration does not qualify as an expense because there was no actual financial outlay.

• Since there are no reliable employee stock option pricing models, it is impossible to determine the fair value of stock-based remuneration. Without changing the underlying assumptions, existing option pricing models would not produce an objective result.

• Adopting the fair value-based technique of accounting for employee stock option plans will make it more difficult to compare financial performance between different organisations.

• Employee stock option expense will lower earnings, which could cause a decline in stock values.
However, a lot of businesses and professional associations are in favour of depreciating employee stock option schemes. The following are the main justifications offered for expense recognition:

• When corporations award employee stock options, even when there is no actual monetary outlay on the part of the company, the issued stock options nonetheless constitute a meaningful consideration for employees. Regardless of whether payment is made in cash, other products, or services, the advantages received by employees result in a cost.

• It would only be appropriate to disclose the stock-based compensation expenditure in the income statement given that businesses can deduct taxes from employee remuneration when options are sold after the required holding period has been met.

• If corporations repurchase shares in the market after employees exercise their stock options in order to maintain a consistent number of outstanding shares, then employee stock options may result in actual cash expense.

• By deducting the cost of stock-based compensation from income, investors would be given a more accurate view of the financial situation of the companies.
Even though the idea to expense employee stock option programmes first surfaced in 1993 with the release of the Exposure Draft that preceded SFAS 123, only two businesses in our study—the Coca-Cola Company and JPMorgan Chase & Co.—have actually begun doing so. We also came to the conclusion that if there were a global uniform standard and more accurate employee stock option pricing models produced, many of the responding corporations would switch to the fair value based way of accounting for stock-based compensation expense. However, it appears that businesses will continue the practise of just disclosing stock-based remuneration unless it becomes required to be expensed.

On September 18, 2002, FASB and IASB convened together in Norwalk, Connecticut, USA, and signed a Memorandum of Understanding. According to this Memorandum (www.fei.org/download/2002pr16.pdf), FASB and IASB agreed to adopt compatible, high-quality solutions to current and future accounting difficulties globally. Despite the Memorandum, there has not yet been much agreement on how stock-based compensation programmes should be treated. The intrinsic value-based approach of accounting, which frequently does not result in income statement expenditure, is nonetheless permitted by FASB for employee stock-based compensation expense. IASB, on the other hand, only suggests an approach based on fair value, which invariably results in an expense on the income statement. The question of whether the harmonisation effect will eliminate the current discrepancies is important to all parties involved.

6.2 Suggestions for Further Research

While developing this thesis, scholarly journals and journalists were frequently discussing the topic of expensing stock-based remuneration. The subject is important, and there are problems that this thesis did not address.

First of all, the IASB has not yet published the standard on share-based payment accounting. On March 7, 2003, the deadline for comment letters on ED 2 will pass. Studying the final standard and its consequences for businesses would be of utmost importance.

Another intriguing study may be conducted on American businesses who switched from using the fair value-based strategy to the intrinsic value-based method. There may be some intriguing and worthwhile conclusions that can be drawn from the motivations for the change, the transition strategies chosen, and the outcomes of the shift.

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