increasing thenumberof sharesoutstanding.This potential
dilutioneffectfromoptionsoutstandingwillreducethevalue
ofequitypershare,andwilldosomoreatfirmsthathave
moreoptionsoutstanding(asapercentofoutstandingshares)
thanatfirmswithless.Figure11.2,reportedearlier,notedthe
differencesintheoptionoverhangatfirmsinoldeconomy,
new economy, financial services, and utility companies.
Analysts and accountants have tried to grapple with the
potential value loss from dilution by using fully diluted
numbers of shares (where all options are treated as
outstanding shares) or partially diluted numbers of shares
(where only in-the-money options are considered) when
computing the earnings per share. Thesemeasures do not
reflect or even attempt to measure the probabilities that
optionswillbeexercisedandthusprovideonlyaveryrough
proxy for the dilution effect.
Therearesomewhoarguethattheredoesnothavetobea
dilutioneffectfromoptionexercise.Manyfirms,theynote,
repurchase stock and set it asideto cover optionexercise
ratherthanissuingnewshares.Thatistruebutsuchactions
stillaffectvaluepersharebyaffectingexpectedcashflows.
In the absence of theseoptions, thestockholders of these
firmswouldhavebeenabletolayclaimtomuchlargercash
flowseachyear(eventhoughtheymightnothavereceived
them as dividends).
Future Earnings
EffectLookingatoptionsgrantedinthecurrentyear(andthe
effectonearnings)andcumulativeoptions(andthedilution
effect)allows analyststoconsidertheeffectofpast option