A lot of talk over the last few years has been devoted to
expensing stock options on the P&L. The logic is investors can't
properly value a public company with options being expensed. I don't get
it!
According to Brealey
& Myers the value of a business is determined by the present value of
its cash flows. After you estimate the businesses cash flow and discount
it back to the present day, you adjust for cash and debt and then get the
company’s equity market value. To determine the per share price you
simply divide this number by the fully diluted shares outstanding. This
last part is particularly important for public companies with options.
Specifically, the denominator (i.e. the shares outstanding) will continue to
grow assuming employees are exercising options.
If this is the case, then an investor simply needs to make an assumption how
much the share base with grow (or decrease) going forward. This simple
fact accounts for the true cost of options and why I think it is irrelevant to
expense options on a P&L. In fact, expensing options using Black
Scholes will create even more uncertainty as public companies will be able to
easily manipulate the true cost of options (like they do with pension plans).
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Why the big deal over options expensing?
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