The Economic and Legal Consequences of Requiring the Expensing of Employee Stock Options Without Specifying the Valuation Method

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Summary

Since mid-2002, the Financial Accounting Standards Board has been pressed to require that companies include the “fair value” of employee stock options, as calculated using an option-pricing model such as Black-Scholes, as an expense in their GAAP financial statements. However, existing models for valuing options, including Black-Scholes, have serious deficiencies when used on long-term options.

The authors find that requiring companies to expense options in the absence of any satisfactory method to evaluate their costs would be inconsistent with the principles and objectives of accounting and would create serious legal risks for companies.

Kevin A. Hassett is the director of economic policy studies and a resident scholar at AEI. Peter J. Wallison is a resident fellow at AEI.