Havingestimatedthevalueofexpectedfutureoptionissues,
weareleftwith anotherquestion: Shouldweconsiderthis
valueeachperiodasanoperatingexpenseandcomputethe
operating income after the expense? If we do, we are
assuming, then, that option issues form part of annual
compensation. Alternatively, we can treat the value as a
capitalexpenseandamortizeitovermultipleperiods.While
the cash flow in the current period is unaffected by this
distinction,ithasconsequencesforthereturnoncapitaland
reinvestment rates that we measure for a firm.
It is important that we do not double countfuture option
issues. The current operating expenses of the firm may
alreadyincorporatetheexpenseofemployeeoptionsinoneof
two ways:
1.Ifthefirmisexpensingoptionatfairmarketvalueatgrant
time,thecurrentearningswillreflectthevalueoftheoption
grantinthemostrecentyear.Ifweforecastfutureearnings
basedonthiscurrentincome,weareimplicitlyassumingthat
thefirmwillnotonlycontinuetograntoptionsinthefuture
but also thatthevalue of optiongrants willremain atthe
current period’s proportion of revenues.
2.Ifthefirmisnotexpensingoptions,thecurrentearningsof
thefirmmay alreadyinclude theexpenses associated with
option exercises in the current period. If the effect on
operatingincomeofoptionexerciseinthecurrentperiodis
lessthantheexpectedvalueofnewoptionissues,wehaveto
allowforanadditionalexpenseassociatedwithoptionissues.
Conversely,ifadisproportionatelylargenumberofoptions
were exercised in the last period, we have to reduce the