In valuing employee options, however, there are five
measurementissuesthatwehavetoconfront.Onerelatesto
thefactthatnotalloftheoptionsoutstandingarevested,and
that some of the nonvested options might never become
vested. The second centers on the illiquidity of employee
options. As a result, employeeoptions are oftenexercised
beforematurity, makingthem lessvaluable thanotherwise
similartradedoptionsthataremarketable.Thethirdrelatesto
the stock price to use in valuing these options. While
conventionaloptionpricingmodelsarebuiltaroundusingthe
current market priceas a key input,we do come upwith
estimatesofvaluepersharewhenwevaluecompanies,and
these estimates can be very different from current stock
prices. We haveto consider whetherwe want to use our
estimatesofvaluepershare,ratherthanthemarketprices,to
preserve valuation consistency.
Thefourthissueistaxation.Aswenotedearlierinthesection
onaccountingfor options, firmsareallowed todeduct the
difference between thestock and the exercise price of an
optionatexerciseandthereispotentialtaxsavingatthetime
ofoptionexercise.Thefinalissuerelatestooptionsgrantedat
privatefirmsorfirmsonthevergeofapublicoffering.Key
inputstotheoptionpricingmodel,includingthestockprice
andthevariance,cannotbeobtainedforthesefirms,butthe
options have to be valued nevertheless.
Vesting
As noted earlier in the chapter, firms granting employee
optionsusuallyrequirethatemployeesreceivingtheoptions
staywiththefirmforaspecifiedperiodfortheoptionstobe
vested. Consequently, when we examine the options