...Stock Options Stock options are a privilege given to an employee to purchase shares of company stock. They give the employee the right to buy common stock from the company at an agreed upon price, also known as the “strike price.” If the value of the stock increases above the agreed upon price, the employee gains additional profit, other than their compensation, from the sale of the option. The purpose of stock options is to give the holder a certain bind to the company’s success. Stock options are very popular as more than 10 million Americans own them today. Stock options meet the objectives of an effective compensation program. Effective compensation programs are ones that motivate employees to high levels of performance, help retain executives and allow for recruitment of new talent, base compensation on employee and company performance, maximize the employee’s after-tax benefit and minimize the employee’s after-tax cost and use performance criteria over which the employee has control. GAAP now requires that stock options be expensed, however GAAP previously required that the excess of the market price of the stock over its exercise price measure compensation cost at the grant date. The company would therefore not recognize any compensation expense related to the options because at the grant date, the market price and the exercise price were the same. If a company has a stock option plan, compensation expense should be recorded during the period(s) in which the...
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...Many companies use employee stock options plans to compensate, retain, and attract employees. These plans are contracts between a company and its employees that give employees the right to buy a specific number of the company’s shares at a fixed price within a certain period of time. Employees who are granted stock options hope to profit by exercising their options at a higher price than when they were granted. Employee Stock Options Plans should not be confused with the term "ESOPs," or Employee Stock Ownership Plans, which are retirement plans. Here’s an example of a typical employee stock option plan: an employee is granted the option to purchase 1,000 shares of the company’s stock at the current market price of $5 per share (the "grant" price). The employee can exercise the option at $5 per share—typically the exercise price will be equal to the price when the options are granted. Plans allow employees to exercise their options after a certain number of years or when the company’s stock reaches a certain price. If the price of the stock increases to $20 per share, for example, the employee may exercise his or her option to buy 1,000 shares at $5 and then sell the stock at the current market price of $20. Companies sometimes revalue the price at which the options can be exercised. This may happen, for example, when a company’s stock price has fallen below the original exercise price. Companies revalue the exercise price as a way to retain their employees. If a dispute...
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...An employee stock option plan (also called a share-based compensation plan) is a compensation arrangement (award) established by a corporation. Under this plan, its employees, in exchange for their services, receive shares of stock, share options, or other equity instruments (or the corporation incurs liabilities to employees in amounts based on the price of its stocks). Mr. Lay’s option plans were considered as compensatory. A noncompensatory employee plan (share purchase plan) is designed by a corporation to raise capital or to obtain more widespread employee ownership of the corporate stock. Three criteria must be met for a share option plan to be noncompensatory: 1. Substantially all employees who meet limited employment qualifications may participate in the plan on an equitable basis. 2. The discount from the market price does not exceed the per-share amount of stock issuance costs avoided by not issuing the stock to public. A purchase discount of up to 5% automatically complies with this criterion. 3. The plan has no option features other than the following: (a) employees are allowed a short time (no longer than 31 days) from the date the purchase price is set to decide whether to enroll in the plan, and (b) the purchase price is based solely on the market price of the stock on the purchase date, and employees are permitted to cancel their participation before the purchase date and obtain a refund of any amounts previously paid. If all these criteria are met, the...
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...Employee Stock Option By Vani Singh An assignment submitted in partial fulfillment of the requirement for FIN 609A School of Business Management National University Prof.: Dr. Farhang Mossavar-Rahmani March 20, 2012 Executive Summary Stock options play a vital role in the success of today’s companies. Stockholders provide stock options to their employees at all levels as an incentive because this helps them to retain, attract and motivate employees. In the past, stock options were given only to the executives because their goal was to maximize the wealth of the company. Lower level employees play an extensive role in helping executives attain this goal. Hence, stockholders decided to give employees stock options to give them the feel of ownership because this would motivate them to take the company toward success. There are two types of stock options: restricted and unrestricted. The restricted stock option restricts employees from exercising the stocks before the stated period of time. Whereas, an unrestricted stock option is a cash award equivalent to the share value, but the employee does not get the actual stock. Both company and employees get stock option tax benefits. Stock options impact the financial statements of the company; it is either considered as an expense or cost to the company. In both cases, the debt of the company increases, thereby providing a tax deduction. Stock options maximize employees’ personal wealth as well as the company’s...
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...Accounting for Stock Options http://www.nysscpa.org/printversions/cpaj/2005/805/p30.htm Print Accounting for Stock Options Update on the Continuing Conflict By Nicholas G. Apostolou and D. Larry Crumbley AUGUST 2005 - In December 2004, a decade after bending to Congressional pressure and backing away from requiring the expensing of options on financial statements, FASB issued a revised standard to recognize stock-option compensation as an expense on income statements. Many in Congress may try to thwart the proposal before it becomes effective. A bill by Representative Richard Baker of Louisiana that would require expensing the cost of stock options for only the top five executives of a company has drawn the support of those groups still resolutely opposed to expensing. This time, however, FASB is likely to prevail. Investors are demanding tougher accounting standards, and the International Accounting Standards Board (IASB) has already passed rules requiring the expensing of options. Many large U.S. corporations have already voluntarily agreed to expense options. Finally, there is more concern about, and less support for, Congressional interference in FASB’s standards-setting process. History of the Debate Accounting for stock options has been one of the most controversial topics in accounting during the last decade. The principal debate is whether compensation expense should be recognized for stock options and, if so, the periods over which it should be allocated. Before...
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...Why is backdating stock options done? What must companies do to make the action legitimate? Trying to find ways to increase the value of one’s personal bank account, inventive ways of accounting have become common place in business. Companies that trade stock on the open market have been known to issue stock options to the employees. It has been found that some companies wait until the price of the stock reaches the lowest point before issuing the stock options to employees to help to achieve the maximum gain from the price increase of the stock. While attempting to predict the lowest point of the price of stock the window is missed and the stock value begins to increase. Some executives have taken it upon themselves to backdate the stocks when they are being granted to senior executives. This is not an illegal action if the proper protocol is followed. Many companies failed to follow the protocol and chose to instead cover up the backdating. Proper protocol demands the action be disclosed in full to the shareholders as well as disclosing the action correctly on taxes and have it reflected in the earnings. When backdating stock options the results can cause lower than expected earnings if reported properly. This in turn can cause a company to miss the expected earnings levels and have an effect on the overall stock price and the earnings of the executives’ stock options. Prior to 2002 the practice of backdating was done several times by KLA-Tencor...
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...Is stock option backdating ethically defensible? Background Stock options are widely used to supplement the amount of non-performance-based cash compensation for executives and CEOs. Furthermore, Bishara & Schipani state that stock options, “have long been touted as a way to align the interests of the executive with the shareholder…”(2008, p. 13) and thus provide, “greater incentives for executives to improve firm performance.” (Raiborn et al. 2007, p.1) However, due to the transactional nature of options that they can be cashed in there exists motivation for executives or firms to manipulate the price so as to receive the greatest gain. Prior to 2002, a company was not required to, “report the issuance of stock options until after the close of the fiscal year.” (Raiborn et al. 2007 p.3 ) As such many firms decided to retroactively increase the value of their share options, particularly executives options. However, by 2002, the time the control measure, Section 403 of the Sarbanes-Oxley act, was passed, 1 out of every 5 companies were suspected to still utilise the practice. Widespread backdating caused a media stir in 2006, with prominent companies such as Comverse and UnitedHealth being indicted. This caused a ripple through the business community as other organisation came under investigation. In 2006, 173 companies were purported to have retroactively altered the stock options of prominent members of their organisations. Retroactively dating options is defined as...
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...Stock Options Stock options as a term is getting a mention in almost every offer letter sent out in the present world, especially for the executives and senior management positions. According to Hall (2000), the choice, of the employee, to decide whether or not to buy the shares of the employer organization on a particular price, is a broad meaning of the term stock options. The specific price in these options is termed as the exercise or strike price. These options are given to the employee by the employer wherein there is no pre-requisite that the employee needs to buy the stocks, rather it is a matter of choice for the person. Furthermore, these options only offer its owner to earn profit by selling them at higher price, whenever there is a chance. The employer does not give the individual the stocks through this mechanism, which is the key differentiator between giving the options to the employee and granting him/her the stocks. Thus employee does not have any dividend benefit and the gains below strike price do not exist. The options, based on the strike price, can be offered to the employee in two ways – out of the money, and in the money (Hall, 2000). Former is an approach where the employee is given the options when the market price of the stock is same as that of the strike price. On the other hand, if the individual gets to buy the stocks at a price less than the prevailing market price, then it would be termed as in the money option. Out of money is more commonly...
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...Date: MAY 1992 Subject: Valuing stock options in a compensation Package Purpose: To determine which option worth for Mrs Jameson, and how long should she stay at Telster. Q1,2: The stock currently trading at $18.75. (20.25-18.75)x3000=4500. If she choose cash compensation package and if there is no TAX, She will receive $5000+(5000x3.8%). Obviously it is worth than stock option. Q3: The options do not vest until the fifth year and the strike price is $35. What is the price of the 5-year option? If Jameson chose stock options, she would hold European 3000 call options (early exercise is impossible) on stocks without dividends which give her the right to buy Telstar stocks at the strike price $35 per share in the 5th year from the date she joins Telstar. The option price is $2.65. Total value of 3000 call options that Jameson would receive is 3000 x $2.65 = $7943 (taxes and transaction costs are ignored), which is option premiums that Jameson can receive if she sells her 3000 granted options. Q4: If Jameson chose cash compensation package and if there is no tax, she will receive $5000 today. If she used this money to invest in 5-year T-bills, the future value of her compensation would be worth: $5000 x 1.0602 = $5301 in 5 years. $7943 is worth than $5301. If she accepts deal (stock option and job), she should untie her wealth from the fortunes of Telstar by using bull spread strategy, which is to sell identical call options with higher strike price, for instance...
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...Empirically Consistent Model for Stock Price and Option Pricing HUADONG(HENRY) PANG∗ Quantitative Research, J.P. Morgan Chase & Co. 277 Park Ave., New York, NY, 10017 Third draft, May 16, 2009 Abstract In this paper, we propose a novel simple but empirically very consistent stochastic model for stock price dynamics and option pricing, which not only has the same analyticity as log-normal and Black-Scholes model, but can also capture and explain all the main puzzles and phenomenons arising from empirical stock and option markets which log-normal and Black-Scholes model fail to explain. In addition, this model and its parameters have clear economic interpretations. Large sample empirical calibration and tests are performed and show strong empirical consistency with our model’s assumption and implication. Immediate applications on risk management, equity and option evaluation and trading, etc are also presented. Keywords: Nonlinear model, Random walk, Stock price, Option pricing, Default risk, Realized volatility, Local volatility, Volatility skew, EGARCH. This paper is self-funded and self-motivated. The author is currently working as a quantitative analyst at J.P. Morgan Chase & Co. All errors belong to the author. Email: henry.na.pang@jpmchase.com or hdpang@gmail.com. ∗ 1 Electronic copy available at: http://ssrn.com/abstract=1374688 2 Huadong(Henry) Pang/J.P. Morgan Chase & Co. 1. Introduction The well-known log-normal model for stock price was first proposed...
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...million Microsoft Stock Options, we started by examining the value by using the Black-Scholes Valuation method. We were given that the time period would be T=6 years, and that both the strike price (K) and the Stock Price (S0) were equal to 66.625. When examining the case provided, it gave the data for both volatility and the risk-free rate in 2000. The volatility for this case in 2000 was 0.33 and the risk-free rate was 6.20%. Next, we calculated d1 and d2 in order to evaluate the price of the call option. D1 and d2 were both calculated at 0.63427 and -0.17406, respectively. This was determined by using the formulas to find d1 and d2 using the Black-Scholes method of valuation. Lastly, using the Black-Scholes method, the price of the call following all of these conditions was determined to by $29.31. So, the value of 70 million options is simply 70 million multiplied by the price of the call, $29.31. This was found to be $2,052,045,496.29. This data can be seen in Table 1 in the appendix. Next, I examined the value of the 70 million options when T followed the distribution of: 10% at 4 years, 20% at 5 years, 40% at 6 years, 20% at 7 years, and 10% at 8 years. Following this distribution set, and calculating the summation of all 70 million options at each different time, T, gave a smaller valuation when compared to the value of all 70 million options at one time, T=6 ($2,040,710,000.00 vs all at T=6, $2,052,045,496.29). The following distribution of the call options at different...
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...The Case of the Underwater Options Evaluation Professor Coleman EMIS 3375 15 April 2014 Leanne Gallagher took a job as the senior software engineer at the start-up corporation MoniMed that was expected to go public within the following year. She was offered a salary of $85,000 with the option to buy 30,000 shares of stock in the company for 30 cents a share. She knew the risks of taking a pay decrease of $20,000 and that the stocks might not increase in price. Gallagher also wanted more information on the company’s financial standing before she accepted the job, but after one phone call she gave up her search. She saw that the typical target price for medical start ups was $10 during the initial offering. She would lose $20,000 from her salary decrease, but make $262,000 from 30,000 shares in the company. This was not guaranteed and no one at the company could promise these results, but she took the risk anyways. Grantz, the founder and CEO of the company, sold MoniMed to CV Diagnostix just prior to the IPO causing the price of shares to drop to 27 cents per share. Gallagher and the other employees suffered while Grantz made $2.5 million on the acquisition. Was Grantz ethically wrong to withhold the financial status of the company from his employees and shareholders because it prevented them from making an informed decision? By analyzing this case according to the Act Utilitarian theory, it was immoral for the CEO and founder Barry Grantz to withhold the financial...
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...Bobby’s Burgers is a large restaurant chain with nearly 10,000 units worldwide. It is experiencing incentive problems among its outlet managers. The managers are not working very hard and are letting quality deteriorate at their units. CEO, Bobby Jones, is considering a stock plan where each unit manager would be given 500 shares of stock in Bobby’s Burgers. He reasons that making the managers part owners of the company will motivate better service. (Brickley, Smith & Zimmerman, 2009, p. 466). By opening up stock options to Bobby’s Burgers managers, they are creating incentives to drive the overall value of the firm, positively, in a forward direction. Management’s performance will improve drastically if the ability to increase their own worth is available. With 10,000 units world wide, and 500 shares of stock available, program incentives are a definite plus for getting management on their feet. My concern would be the approach he takes to implement this program. The ideal solution would be to spread the word to its management about the program, and set a date as to when they will be monitoring performance improvements. This is how they will gauge which units take the incentive seriously, and who to award the incentives too. Obviously Bobby’s Burgers cannot justify giving 500 shares to its managers in 10,000 units worldwide. The goal would be to compensate the mangers that have show continued performance improvements. Another way to increase performance would be to offer salary...
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...Analyzing Managerial Decisions: Granting Stock Options by HCM-540, MBOL5, Health Care Organization Instructor: Saint Leo University Distance Learning December 8, 2013 Analyzing Managerial Decisions: Granting Stock Options Ronald J. Sanders Saint Leo University MBA540 Analyzing Managerial Decisions: Granting Stock Option There are a number of studies that would argue a different method of motivating employees or offer advice in ways of accomplishing a task. Each way is supposedly, the best way to get the best results. The fact is, the no two people are the same and each has a different motivating factor. The thing that motivates one may not be what motivates the other. I am motivated by the positions of authority and money. Any other recognition would barely hold water with. My wife, has a different motivation. She enjoys helping people and gets a greats sense of worth from being appreciated, and recognized and valued as an employee. The way she sees it, someone taking the time out of their schedule to show appreciation is valued more than money. She will likely give you more effort and dedication for those types of praises. She will become more loyal at every show of appreciation; working for appraisal versus simply a normal pay raise. For me, money is what motivates me finding ways to increase the dollar value is always a challenge. The company, Bobby’s Burger, Bobby Jones is challenged with a similar situation; how to challenge his managers to exert...
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...were residents of the State of Georgia. Plaintiff Donald Schroerlucke is a former employee of WorldCom, Inc. In 1989, Mr. Schroerlucke was employed as Vice President of Operations at Long Distance Discounts Services, Inc., the predecessor corporation to WorldCom. Pursuant to stock option agreements with Long Distance Discount Services, Inc., and then with WorldCom, Mr. Schroerlucke accumulated employee stock option grants between July 1991 and January 1998. Mr. Schroerlucke’s employment with WorldCom ended on January 4, 1999, at which time his stock options became fully and immediately vested according to the terms of the stock option agreements and an April 7, 1998 memorandum titled, “WorldCom Employee Stock Option Program,” once his employment ended, Mr. Schroerlucke was required to immediately exercise all of his employee stock options. The April 7, 1998 memorandum stated in part: “Please note that under WorldCom Inc. 1997 Stock Option Plan, all vested options must be exercised prior to termination with the Company.” After a final stock option grant award on January 2, 1998, Mr. Schroerlucke had accumulated 172,492 WorldCom stock options. Mr. Schroerlucke exercised all of his existing stock options on February 12, 1999, at which time the market value of his 172,492 WorldCom shares was 13,702,333.25, based on the...
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