option grants at fair market value. Such expensing, it is
argued, will catch the market by surprise and lead to
significantvaluationreassessments,atleastatcompaniesthat
have disproportionately large option grants. A study of
companiesthathaveswitchedtoexpensingin 2002 and 2003
suggests thatthese fears may be misplaced.In this study,
companies that switched to expensing options experienced
neither positive nor negative returns; in other words, the
expensing,by itself, had no effect on value,which would
imply that the valuations of these companies effectively
incorporated the option expensing prior to its happening.
30
At therisk of oversimplifying thedebate, we believe that
there are ways in which we can resolve the differences
betweenthesestudies.Thestudiesthatfindthatequityvalues
incorporatetheexistenceand potentialdilutionthatwillbe
caused by options are generally right. Most investors and
analystsdoconsideremployeeoptionswhenvaluingstocks
butonlyinaveryroughsensebyusingfullydilutedearnings
per share in making valuationjudgments. Thestudies that
find negative stock price reactions to option exercise are
probably also right, at least for firms that have made
disproportionately large option grants (relative to other
companies in thesector) orat excessively favorable terms
(vesting and exercise price).
Whataretheimplicationsforstockpriceswhenallcompanies
willhavetoexpenseoptiongrantsnextyear?Assumingthat
firmsdonotchangetheiroptiongrantingbehaviornextyear,
thetransparencyoftheexpenseassociatedwithoptiongrants
willleadtoreassessmentsofvalueofequitypershareatsome
companies,withvaluespershareincreasingatcompaniesthat