assumption. For instance, we could assume that options
issuedwillrepresentafixedpercentoftheoutstandingstock
eachperiod,andbasethisestimateonthefirm’shistoryoron
theexperienceofmorematurefirmsinthesector.Generally,
thisapproachismorecomplicatedthanthefirstone(option
valueasanoperatingorcapitalexpense)anditdoesnotlead
to a more precise estimate of value. Clearly, it would be
inappropriatetodoboth—showoptionissuesasanexpense
andallowforthedilutionthatwilloccurfromtheissue.That
double counts the same cost.
Does the Market Value Employee Options Correctly?
Thedebateabouthowbesttoincorporateemployeeoptions
into estimates of value becomes academic if the market
consistentlyfailstoaccountforthemwhenvaluingequityper
shareincompanies.Infact,manyanalystsarguethatbeing
sloppyaboutemployeeoptionsineitherdiscountedcashflow
valuationorrelativevaluationcreateslittleincostsbecause
themarketisalsosloppyinitsassessments.Therearethree
dimensions on which we can consider how markets view
employeeoptions:Howdomarkets reactwhenoptions are
granted to employees? How do markets react when
employees exercise their options? Does the market
incorporate theoption overhang when valuing equity in a
publiclytradedcompany?Theevidenceoneachquestionis
presented here:
1.Pricereactiontooptiongrant.Thereisnoevidencethatthe
marketreactsnegativelytooptiongrantsbycompanies.There
aresome whobelievethatthis is becausecompanies have
historicallynot shown theseoptiongrantsas expenses,but
thereisnoreasontobelievethatoptiongrantsthemselvesare