ACCOUNTING FOR EMPLOYEE STOCK OPTIONS: A PRACTICAL APPROACH TO HANDLING THE VALUATION ISSUES

Abstract

In this paper we argue that employee stock options should be expensed on the grant date and then marked to market on subsequent reporting dates. One of the advantages of our approach is that the cumulative amount expensed for a stock option over the whole of its life does not depend on the option pricing model used. The option pricing model influences only the way in which expenses are allocated to time periods. Our paper proposes an option pricing model appropriate for employee stock options. The model explicitly considers the vesting period, the possibility that employees will leave the company during the life of the option, the inability of employees to trade their options, and dilution issues.