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An IFRS 2 and FASB 123 (R) Compatible Model for the Valuation of Employee Stock Options

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  • Manuel Ammann
  • Ralf Seiz

Abstract

In this paper, we show how employee stock options can be valued under the new reporting standards IFRS 2 and FASB 123 (revised) for share-based payments. Both standards require companies to expense employee stock options at fair value. We propose a new valuation model, referred to as Enhanced American model, that complies with the new standards and produces fair values often lower than those generated by traditional models such as the Black–Scholes model or the adjusted Black–Scholes model. We also provide a sensitivity analysis of model input parameters and analyze the impact of the parameters on the fair value of the option. The valuation of employee stock options requires an accurate estimation of the exercise behavior. We show how the exercise behavior can be modeled in a binomial tree and demonstrate the relevance of the input parameters in the calibration of the model to an estimated expected life of the option. Copyright Swiss Society for Financial Market Research 2005

Suggested Citation

  • Manuel Ammann & Ralf Seiz, 2005. "An IFRS 2 and FASB 123 (R) Compatible Model for the Valuation of Employee Stock Options," Financial Markets and Portfolio Management, Springer;Swiss Society for Financial Market Research, vol. 19(4), pages 381-396, December.
    • Handle: RePEc:kap:fmktpm:v:19:y:2005:i:4:p:381-396
    DOI: 10.1007/s11408-005-6458-2
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    References listed on IDEAS

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    1. Hall, Brian J. & Murphy, Kevin J., 2002. "Stock options for undiversified executives," Journal of Accounting and Economics, Elsevier, vol. 33(1), pages 3-42, February.
    2. Smith, Cw & Zimmerman, Jl, 1976. "Valuing Employee Stock Option Plans Using Option Pricing Models," Journal of Accounting Research, Wiley Blackwell, vol. 14(2), pages 357-364.
    3. Detemple, Jerome & Sundaresan, Suresh, 1999. "Nontraded Asset Valuation with Portfolio Constraints: A Binomial Approach," The Review of Financial Studies, Society for Financial Studies, vol. 12(4), pages 835-872.
    4. Cuny, Charles J. & Jorion, Philippe, 1995. "Valuing executive stock options with endogenous departure," Journal of Accounting and Economics, Elsevier, vol. 20(2), pages 193-205, September.
    5. Carpenter, Jennifer N., 1998. "The exercise and valuation of executive stock options," Journal of Financial Economics, Elsevier, vol. 48(2), pages 127-158, May.
    6. Cox, John C. & Ross, Stephen A. & Rubinstein, Mark, 1979. "Option pricing: A simplified approach," Journal of Financial Economics, Elsevier, vol. 7(3), pages 229-263, September.
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    Cited by:

    1. Douglas Cumming & Sofia Johan, 2006. "Provincial preferences in private equity," Financial Markets and Portfolio Management, Springer;Swiss Society for Financial Market Research, vol. 20(4), pages 369-398, December.
    2. Douglas Cumming & Sofia Johan, 2007. "Advice and monitoring in venture finance," Financial Markets and Portfolio Management, Springer;Swiss Society for Financial Market Research, vol. 21(1), pages 3-43, March.

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