Accounting for Employee Stock Options

Transcription

1 Accounting for Employee Stock Options Arnaud van Oers June 2001 Post Graduate Program Chartered Controller University of Maastricht University of Amsterdam Washington University in St. Louis

2 Preface Annual reports are prepared to inform internal and external stakeholders (especially shareholders) about the well being of the company. The auditor clarifies that the financial statement gives a true and fair view of the financial position of the company. In the annual accounts all financial transactions should be recorded. The application of accounting rules gives a lot of possibilities for interpretation, especially accounting for accruals and provisions. This is where subjective norms enter into the field of accounting, which is perceived to be a relative abstract science that leaves no room for discussion. In this thesis I will elaborate on the possibilities of interpretation and discussion on applied accounting rules in the respect of Employee Stock Options. This thesis is written as part of my study at the University of Maastricht and Amsterdam in cooperation with the Olin School of Business of Washington University in St. Louis. In the wide variety of subjects taught during the course, this thesis is written under the supervision of Mr. Langendijk, responsible for the course topic Financial Accounting. 1

3 Contents PREFACE... 1 CONTENTS INTRODUCTION AWARDING EMPLOYEE STOCK OPTIONS PRO S CON S INTERNATIONAL AND NATIONAL ACCOUNTING STANDARDS INTERNATIONAL ACCOUNTING STANDARDS (IAS) UNITED STATES (US GAAP) UNITED KINGDOM (UK GAAP) NETHERLANDS (DUTCH GAAP) SUMMARY CONCLUSION VALUATION OF AN EMPLOYEE STOCK OPTION MARKET VALUE OF AN EMPLOYEE STOCK OPTION INTRINSIC VALUE HISTORICAL COST METHOD FORECAST GROWTH METHOD THE FAIR VALUE MODEL LITERATURE CONCLUSION RECOGNITION DATE OF AN EMPLOYEE STOCK OPTION IS AN OPTION EQUITY OR DEBT? GRANT DATE SERVICE DATE VESTING DATE EXERCISE DATE CONCLUSION

4 6 G4+1 POSITION PAPER: ACCOUNTING FOR SHARE-BASED PAYMENTS AN EMPLOYEE STOCK OPTION IS EQUITY AN OPTION PRICING MODEL SHOULD BE USED TO VALUE AN EMPLOYEE STOCK OPTION VESTING DATE SHOULD BE USED AS RECOGNITION DATE COMMENT LETTERS ON THE DISCUSSION PAPER EMPLOYEE STOCK OPTIONS IN THE ANNUAL REPORTS REPORTING EMPLOYEE STOCK OPTIONS ACCORDING TO IAS REPORTING EMPLOYEE STOCK OPTIONS ACCORDING TO US GAAP REPORTING EMPLOYEE STOCK OPTIONS ACCORDING TO UK GAAP REPORTING EMPLOYEE STOCK OPTIONS ACCORDING TO DUTCH GAAP CONCLUSION CONCLUSION LITERATURE APPENDIX A THE VALUE OF EMPLOYEE STOCK OPTIONS APPENDIX B OVERVIEW OF COMPANIES APPLYING IAS APPENDIX C OVERVIEW OF COMPANIES APPLYING US GAAP APPENDIX D OVERVIEW OF COMPANIES APPLYING UK GAAP APPENDIX E OVERVIEW OF COMPANIES APPLYING DUTCH GAAP

5 1 Introduction Employee Stock Options are call-options on the shares of the company where the employee is working. Stock options are often only rewarded to the management, therefore Employee Stock Options are also known as Management Stock Options. A stock option gives the employee the right to purchase company stock at a future date, at a price established when the option was granted. Stock options are intended to motivate the executive to manage the company in line with the interests of the shareholder, enhancing the value of the stock option. A stock award creates a close affinity of interests between the management group and the shareholders. For incentive and tax reasons, the option price should be higher than the current price. However, there is evidence 1 that most stock options are issued at the money; that is with an exercise price equal to the existing market price. But options with exercise prices far in- or out-ofthe money do also exist. An Employee Stock Option is a combination between a European option and an American option. Until the date that the employee is allowed to exercise the stock option it is a European option, because it is not transferable and not exercisable. From the date on which the owner is allowed to exercise the option it becomes an American option. Formulation of the problem Accounting for Employee Stock Options is not fully evolved yet. National accounting boards as well as the International Accounting Standards Board are reviewing the accounting rules on Employee Stock Options, especially the presentation in the profit and loss account. In this paper I want to make clear what problems arise in Accounting for Employee Stock Options and try to find a solution to these problems. 1 Lewellen, Park and Ro, 1995, pp

6 Research questions In this thesis I deal with the question How to account for Employee Stock Options? Two relative important parameters are (1) the valuation and (2) the date of recognition of Employee Stock Options. Therefore the sub-questions are (1) How to value Employee Stock Options? and (2) When to recognize Employee Stock Options in the annual accounts? Methodology To answer these questions I have studied the International Accounting Standards and three national accounting rules (chapter three). Furthermore, I have done a literature study (chapters four and five) and a field study (chapter seven) on the Employee Stock Options. The structure of this paper is as follows, in chapter two the advantages and disadvantages of Employee Stock Options are described. In chapter three the emphasis is on accounting for Employee Stock Options according to the International Accounting Standard (IAS) and three different national General Accepted Accounting Principles (GAAP), respectively US GAAP, UK GAAP and Dutch GAAP. In chapters four and five the theory on the valuation and the recognition date of Employee Stock Options is presented and discussed. In the year 2000, the International Accounting Standards Committee (IASC) addressed the valuation and recognition problem and appointed a Working Group, the G4+1 Group. The G4+1 Group issued a discussion paper. This paper Accounting for share-based payments is discussed in chapter six. For the practical part of this paper I have investigated twenty annual reports, five companies reporting according to IAS and five companies that applied respectively US GAAP, UK GAAP and Dutch GAAP. These annual reports are assessed on presentation and disclosures made on accounting for Employee Stock Options. The result of this assessment is presented in chapter seven. Finally, in chapter eight the conclusions of this paper are summarized. 5

7 Limitations and restrictions There are many more questions on Employee Stock Options then answers and also many more questions than can be dealt with in this paper. For example, in this paper the relationship between the value of the Employee Stock Options and the performance of the employee will not be discussed. Another related item that will not be discussed is the minimum number of options that is necessary to motivate and satisfy the employee, or the maximum number of options to award in order to keep the employee employed and to prevent the company for financial retirement of good employees. 6

8 2 Awarding Employee Stock options 2.1 Pro s Agent Principal dilemma The agent principal dilemma is synonymous for the relationship between the shareholder and the manager, with the shareholder being the principal (the owner of the company) and the manager being the agent for the shareholder. The agent does have other interests than the principal. The manager is working for the owner of the company, while the manager does have more information about the company than the principal. This dilemma is minimized if the manager has common interests with the principal. Therefore the employees are given Employee Stock Options to let the employees have interests in line with the interests of the shareholder. Time Frame Difference The management can be focused on short-term results rather than long-term profitability because of the annual awarded bonuses. With stock options, executives are presumed to attempt to influence long-term share price performance rather than short-term profits. Minimizing Risk Averse behavior The management has fewer possibilities of portfolio management and risk pooling. For being employed, the management is heavily dependent on the well being of the company they are working for. The main target for the management is continuity. The management is also more aware of not performing below the market average than out-performing the market. By outperforming the market, the targets for next year will be higher and the bonus will be harder to earn. An option has no downside loss (since the executive does not actually own the stock) and unlimited upside potential. Therefore, executives may be encouraged to reduce risk-averse behavior that would otherwise accompany their ownership of stock to undertake riskier projects with higher payoffs. 7

9 Attracting Staff For start-up companies it is very hard to attract qualified employees, and if they can be attracted the personnel costs are relatively high, because of the risk of continuity the employee has. With awarding the employees with Employee Stock Options, the employees can grow with the company and the awards can be higher than being employed with a traditional company. The employee being awarded with stock options has the potential benefits for the risk undertaken. With awarding stock options it is possible for start-ups to attract qualified staff. Holding Staff Employee Options have a vesting period. When the options are awarded, the options are not directly exercisable. Before the options can be exercised, the employee has to be employed by the company for a certain period (mostly three years). This limitation of the Employee Stock Option ensures the company of retaining qualified staff within the company. 2.2 Con s Market Circumstances The share price and subsequently the option price is dependent on more factors than the management performance only. In situations of an overall growing market the option can become much more valuable although the management is not outperforming the market. The other way around, the management that has outperformed a bear market may not create value for the options. Accumulating effect Because Employee Stock Options are awarded every year, the motivational effect of the options will decline over the years. At the time that the options awarded come to expiration, the options become a yearly increasing cost element. Because every year the awarded number of options have to increase to keep the employees satisfied, the Employee Stock Options become an increasing cost component for the company. 8

10 Immunization effect The Employee Stock Options are implemented as an incentive for the management to perform better and to be paid extra by exercising the options. After a couple of years of collecting the exercise payments, the employee becomes immune to the payment and counts for it as a part of the annual rewards. At the time the options are out-of-the-money at exercise date, the employees will recognize the stock options as a dissatisfier instead of a satisfier. Independence of management The Employee Stock Options have as an advantage the possibility to contract employees for a longer period, because of the vesting period. On the other hand, after a few years of collecting exercise payments, the employee becomes financially independent and has no need to work anymore or at least for less hours a week. The cashing of options enables the management an earlier financial retirement. Conclusion The Employee Stock Option has advantages to focus the management on the interest of the shareholder. With the Employee Stock Option it seems possible to create a less risk averse, long term thinking, shareholder related interested employee, but as described there are also disadvantages and the shareholder has to pay the price for the alignment. If the shareholder can be informed properly about the price (s)he pays for the Employee Stock Option will be discussed in this paper. 9

11 3 International and National Accounting Standards Internationally there is material difference in reporting on Employee Stock Options. Four different methods of accounting are described. First is described accounting according to the International Accounting Standards (IAS). These standards do not have any legal right, but give guidelines for different national accounting standards. The national accounting board can implement these guidelines separately. Besides the IAS, General Accepted Accounting Principles (GAAP) in the United States of America (US GAAP), the United Kingdom (UK GAAP) and the Netherlands (Dutch GAAP) are described. 3.1 International Accounting Standards (IAS) In IAS there is one relevant standard on Employee Stock Options. The standard is IAS 19 and there is an interpretation from the Standing Interpretations Committee (SIC): Final Interpretation SIC IAS 19 Employee Benefits Under IAS 19 paragraph 144 and further, the Equity Compensation Benefits are described. Paragraph 144 emphasizes that under IAS employee share options are equity. It is presented as follows: Equity compensation benefits include benefits is such forms as: (a) shares, share options, and other equity instruments, issued to its employees at less than the fair value at which those instruments would be issued to a third party; and (b) cash payments, the amount of which will depend on the future market price of the reporting enterprise s shares IAS does not give standards on recognition or measurement requirements of Employee Stock Options, but only prescribes the disclosure regulation. 10

12 3.1.2 Disclosure under IAS 19 The disclosures under IAS 19 are extensive and described in paragraph 147 and148. Under IAS 19 the following information shall be disclosed: 147. An enterprise should disclose: a. The nature and terms (including any vesting provision) of equity compensation plans b. The accounting policy for equity compensation plans c. The amounts recognized in the financial statements for equity compensation plans. d. The number and terms (including, where applicable, dividend and voting rights, conversion rights, exercise dates, exercise prices and expiry dates) of the enterprise s own equity compensation plans (and, in the case of share options, by employees) at the beginning and end of the period. The extent to which employees entitlements to those instruments are vested at the beginning and end of the period should be specified. e. The number and terms (including, where applicable, dividend and voting rights, conversion rights, exercise dates, exercise prices and expiry dates) of equity financial instruments issued by the enterprise to equity compensation plans or to employees (or of the enterprise s own equity financial instruments distributed by equity compensation plans to employees) during the period and the fair value of any consideration received from equity compensation plans or the employees. f. The number, exercise dates and exercise prices of share options exercised under equity compensation plans during the period. g. The number of share options held by equity compensation plans, or held by employees under such plans, that lapsed during the period; and h. The amount, and principal terms, of any loans or guarantees granted by the reporting enterprise to, or on behalf of, equity compensation plans An enterprise should also disclose: a. The fair value, at the beginning and the end of the period, of the enterprise s own equity financial instruments (other than share options) held by equity compensation plans; and b. The fair value, at the date of issue, of the enterprise s own equity financial instruments (other than share options) issued by the enterprise to equity compensation plans or to employees, or by equity compensation plans to employees, during the period. If it is not practicable to determine the fair value of the equity financial instruments (other than share options), that fact should be disclosed SIC 16 Share Capital Required Own Equity Instruments (Treasury Shares) Treasury shares are described in SIC 16. Treasury shares are of relevance to Employee Stock Options in case a company buys shares in the market to hedge the possible obligation of awarded Employee Stock Options in order to prevent for dilution. The SIC indicates that treasury shares should be presented in the balance sheet as a deduction from equity, and the acquisition of treasury shares should be presented in the financial statements as a change in equity. Additionally, no gain or loss should be recognized in the income statement on the sale, issuance, or cancellation of treasury shares, and consideration received should be presented in the financial statements as a change in equity

13 3.2 United States (US GAAP) Under US GAAP there is a choice of two methods of accounting for Employee Stock Option plans. The first option is reporting according to the Financial Accounting Standards Board (FASB) Statement 123 (fair value method). The second option is reporting according to the Accounting Principles Board (APB) Opinion 25 (intrinsic value method). If FAS 123 is chosen then a company may not choose to revert to APB 25 at a later date. Entities electing to remain with the accounting in Opinion 25 must make pro forma disclosures of net income and, if presented, earnings per share, as if the fair value based method of accounting defined in FAS Statement 123 had been applied APB 25 Accounting for Stock Issued to Employees Under APB Opinion 25 (released 1972) the compensation expense is measured as the access of the market price over the option price on the measurement date. The measurement date is the first date on which both are known (a) the number of shares that an individual employee is entitled to receive and (b) the stock option price or purchase price if any. Commonly this will be the grant date, but if later, then the cost should be measured over the service period using the market price at the end of each intervening period. The costs recognized have to be charged to the expense over the periods in which the employee performs the related services Disclosure under APB 25 Disclosure is made of the status of the option plan at the end of the period, including: - Number of shares under option - Number of shares over which options are currently exercisable - Exercise price - Number of shares exercised during the period, including the exercise price - Pro forma disclosures of net income and earnings per share, as if the fair value based method of accounting defined in statement 123 had been applied. Since the release of APB 25 questions have surfaced about its applications and different practices have developed. The FASB reconsideration of the stock compensation issue culminated in the issuance of FAS Statement

14 3.2.3 FAS Statement 123 Accounting for Stock-Based Compensation Under FAS Statement 123 (released 1995) the compensation cost of the Employee Stock Options is based on the fair value of the option at the date of grant. FAS 123 also allows an entity to continue to measure compensation cost for those plans using the intrinsic value based method of accounting prescribed by APB Opinion No. 25. In FAS 123 the valuation of stock options for employee services is described as follows: 1. The fair value of a stock option (or its equivalents) of a publicly traded company shall be estimated using an option pricing model (Black-Scholes or a-binomial model). This model should take into account: - The stock price at grant date - The exercise price - The expected lifetime of the option - The volatility of the underlying stock - The expected dividends on the stock - The risk free interest rate over the expected lifetime of the option The option is valued at the date of grant and is not subsequently revisited. 2. The fair value of a stock option of a non-publicly-traded company shall be estimated using an option model, but it need not consider the expected volatility of its stock prices. Excluding volatility in estimating an option s value is an amount commonly termed minimum value. The fair value of an option estimated at the grant date is not subsequently adjusted for changes in the price of the underlying stock or its volatility, the lifetime of the option, dividends on the stock, or the risk-free interest rate. FAS 123, Accounting for Stock based compensation, encourages the recognition of cost for the fair value of stock-based compensation paid to employees, but does not require to do so. Under both methods of accounting, companies may buy their own shares as treasury stock to cover their positions with respect to the Employee Stock Options without affecting the accounting for the stock options itself, but note that shares must be shown as a deduction from equity (purchase of own shares). 13

15 3.2.4 Disclosure under SFAS 123 Under SFAS 123 the following information shall be disclosed: 1. The number and weighted average exercise price of options, a) those outstanding at the beginning of the year, b) those outstanding at the end of the year, c) those that may be exercised at the end of the year, d) those granted, exercised, forfeited, or expired during the year. 2. The weighted average grant-date fair value of options granted during the year. 3. The number and weighted average grant-date fair value of equity instruments other than options granted during the year. 4. A description of the method and significant assumptions during the year to estimate the fair value of options, including the following weighted average information of: a) risk-free interest rate. b) expected life. c) expected volatility. d) expected dividends. 5. Total compensation cost recognized. 6. Terms of significant modifications of outstanding awards. 7. For options outstanding at the latest year-end date, the range of exercise prices and the weighted average remaining contractual life shall be disclosed Although FAS123 describes detailed information to be disclosed, the accounting regulations have not been fully implemented throughout all listed companies in the United States, as concluded in the research done by Tang and Conroy 3. The reduction in net income and Earnings per Share (EPS) were not reported due to immateriality. But the authors expect that the majority of the nondisclosing companies will be doing so soon, because the reduction in net income and EPS will become more substantial each year. It needs to be taken into account that at the time Tang and Conroy wrote this article, FAS 123 was implemented with a phase in period, where compensation costs are recognized over the vesting period. 3 Tang and Conroy,

16 3.3 United Kingdom (UK GAAP) Under UK GAAP there is one article to be referred to: UITF 17 The Urgent Issues Task Force (UITF) issued on the 19th October 2000 a revised abstract 17 that supersedes the abstract of UITF 17 Employee share schemes The cost of options awarded to employees is recognized immediately under UITF 17, if they are unconditional on performance criteria (unless clearly unrelated to past performance for example on initial recruitment). If the award of options is conditional upon future performance criteria, the cost should be recognized over the period to which the employee s service relates. In order for share options to be treated consistently with share performance plans, the UITF concluded that as a minimum cost the undiscounted intrinsic value at the date of grant of the option should be recognized as a cash cost. This cash cost should be charged in the profit and loss account. The cost to be accrued for in the profit and loss account must match the period to which the performance criteria relate. The cost should be based on a reasonable expectation of the extent that the performance criteria will be met. Where the company holds shares (in substance) in connection with an option scheme the shares are shown as an asset and their cost may affect the cost of the scheme. The valuation of the stock option is not as detailed as under FASB 123. UITF is most related to the valuation of stock compensation plans and less to the stock option compensation plans. Employee Stock Ownership Plans (ESOP) are described in UITF Abstract 13. Disclosures to be made about management rewards under UK GAAP are described in the paragraphs relating to Directors. Other related disclosures are given for SAYE schemes (Save as you Earn) Disclosure under UITF 17 The disclosures to be made for stock option plans are: - details of number of shares that may be issued under options to subscribe - service date, vesting date and exercise date - exercise price 15

17 3.4 Netherlands (Dutch GAAP) The Netherlands follows the IAS in reporting on Employee benefits, but IAS is not explicit with how to report on Employee Stock Options. The Dutch GAAP (Richtlijnen voor de Jaarverslaggeving) uses the disclosure model. Of importance are guideline 204 Eigen Vermogen (equity) and guideline 271 Aandelenoptieregelingen voor personeel (Employee Stock Options) Disclosures under Dutch GAAP In guideline 204 are described disclosures that have to be made on conditional and unconditional awarded stock options outstanding at the end of the financial year. Disclosures have to be made for every board member separately and for the other employees as a whole. The disclosures to be made are: - Number of options awarded per category - Number of shares and the nominal value of the shares - The exercise price - Expiration date - The most important conditions - If there are specific finance arrangements - Other data that can be of interest to value the options Furthermore the company has to disclose: - Number of options exercised during the year - The exercise price - The number of shares bought in the market - The number of new shares issued Separately the company has to give information on: - How many new options are issued, with the number of underlying shares, the exercise price and the expiration date. In guideline 271 the disclosures are extended with the regulation that if awarded options are in the money, the company has to declare the difference between exercise price and stock price. The difference should be reported in the profit and loss account as a salary component. Taxation on Employee Stock Options paid by the company should also be reported as salary costs. 16

18 The company has to disclose the hedge policy according to the Employee Stock Options, either the company buys shares in the market, buys call options or issues new shares. On balance date, the awarded but not hedged position must be reported and if stocks are bought in the market to cover the option position, the transaction price for the purchase should be reported. The Dutch GAAP does not oblige but recommends that transactions in equity should be reported under other reserves and not as additional paid-in capital. 17

19 3.5 Summary In the matrix below there is a comparison made on the valuation method, the disclosure date and the disclosures to be made under IAS, US GAAP, UK GAAP and Dutch GAAP. IAS US GAAP UK GAAP Dutch GAAP APB 25 FAS 123 UITF 17 Valuation method Fair value X X Intrinsic value X X X Market value Historical cost Forecast growth Recognition date Grant date Service date X X Vesting date Exercise date X X X Disclosures to be made Fair value X X Intrinsic value X X X Number of shares under option X X X X X Number of options granted X X X X X Number of options exercisable X X X Number of options exercised X X X X X Options outstanding beginning of the year X X X X X Options outstanding end of the year X X X X X Number of shares issued X Stock price at grant date X Number of shares bought in the market X Exercise date X X X X X Exercise price X X X X X Expected lifetime of the options X Expiry date X X X X X Expected volatility of the underlying stock X Expected dividends X Risk free interest rate X Nature and Terms X X X X Accounting Policy X X X X Dilution effect Costs charged to P&L 18

20 3.6 Conclusion As discussed in this chapter there are material differences between reporting according to IAS and the applicable rules in the different countries. Only IAS and FAS 123 use the fair value calculation on Employee Stock Options and also the disclosures to be made differ significantly. Dutch GAAP is said to follow IAS but it can be concluded that only FAS 123 is strict following IAS and that APB 25, UK GAAP and Dutch GAAP have great similarities in accounting on Employee Stock Options. 19

21 4 Valuation of an Employee Stock Option To value the Employee Stock Option, different valuation methods can be applied. In this chapter, five valuation methods will be discussed with the advantages and disadvantages of each method. The methods described are the market value, the intrinsic value, the forecast growth model value, the historical cost method and the fair value method. 4.1 Market Value of an Employee Stock Option If comparable options are traded on the open option market, the market valuation method of an Employee Stock Option would be the best value measurement, however an Employee Stock Option is never available in the market. Should an Adjusted Market Value be used? Pro s If the market value of an Employee Stock Option can be determined, this would be the best available alternative to value the Employee Stock Option. An adjustment for non-transferability and delayed exercise possibility could also be taken into account to provide a reasonable basis for the actual value of the option. Cons The characteristics of a non-traded option are too different from traded options, that the market value of a non-traded option is not comparable with the value of a traded option with some similar properties. The exercise price and date can be equal, the volatility can be equal, but the differences between the non-traded and the traded option are significant. The main differences are non-transferability and time to exercise. The non-traded option should be valued being a European option, where the traded option should be valued as being an American option with a possibility to exercise from day one onwards. 20

22 4.2 Intrinsic Value The intrinsic value of the option is the difference between market value of the stock and the exercise price of the option. Pro s The intrinsic value is easy to determine. The intrinsic value is known as the minimum value of the option. It can be determined at any point of time, without an arbitrary component. The intrinsic value can easily be calculated as being the difference between exercise price minus current stock price with a minimum of zero. At the grant date, as well as on any other date, the valuation at intrinsic value can be done without arbitrariness. Cons The value of the exercise price of the option minus the current stock price is not equal to the present value of the option. The time value of the option is not taken into account, while the timevalue of an option is very important. Another aspect is the dividend to be paid on the stock, these are not included in the option price and therefore the intrinsic value is not an appropriate method of calculating the value of the Employee Stock Option. 4.3 Historical Cost Method To ensure that the company can fulfil the promised obligations at expiration date, the company can buy shares in the market. The price paid for the shares is known as the historical cost price. The purchase of its own shares (held in a trust) can also been done before the options are awarded. Pro s The company has coverage for the shares to be delivered at a later date. The costs are fixed and the exposure to the company is minimized. 21

23 Cons The historical cost of the shares especially when they are repurchased before the grant date has no relation with the value of the option. If the shares were bought in the past at a much lower rate, the calculated value of the option has no relation with the current value of the option at grant date. Furthermore, dividend payments are not taken into account when the historical cost method is used. A discount should be made for the undistributed dividend payments and a mark-up should be made for the time value of money. This would give too much complication to calculate a reliable and realistic value of the option 4.4 Forecast Growth Method The forecast growth model calculates the value of the option on the forecast of the future stock price. The forecast is based on the assumed annual growth rates in the stock price. Pro s The calculation of the Forecast Growth Model with a binomial chart is a valuation on the basis of a European option, which has similarities with the Employee Stock Options, because of the delayed exercise possibility. The traded options can give the market expectation of the future stock price. Cons The future growth rate of stock prices is not available. Insiders of the company have to make an expectation of the growth rate, while the same employees are awarded with the option on the stock price. The future stock price can not be forecasted. 22

24 4.5 The Fair Value Model The fair value would be the market value of an Employee Stock Options, but because of the absence of the market price an alternative is needed to calculate the fair value. One method of determining the fair value is valuing the payments that would have been made to the employees if no options were awarded. If there were no options awarded to the employee, the employee should have been compensated with other emoluments. The valuation of the other emoluments or cash equivalents could be an indication of the value of the awarded options. This does not seem to be an appropriate method and consequently the only method left to determine fair value is a theoretical approach. A model can be used to value the Employee Stock Option. Financial analysts often use the Black and Scholes model to determine the value of options. Further details on the Black and Scholes model are described in appendix A. Pro s The use of a model is objective. A model can be improved over time and therefore can be adjusted in the future without changing accounting rules. A model can be translated into a spreadsheet and can easily calculate the value of the option. Cons A model will only be a representation of reality and will never meet the reality. Depending on the input, this representation can be better or worse. The model mostly used in the financial world is the Black and Scholes option model, but as described before, this model has its limitations in representing the real world, but is (at this time) a generally accepted method of calculating the value of an option. 23

25 4.6 Literature Having discussed the advantages and disadvantage of the different ways of valuing the Employee Stock Option it is clear that it is hard to determine the best way of valuing. In the literature different approaches are offended and defended. Samuels and Lymer 4 distinguish four valuation methods: market price, intrinsic value, forecast growth and the mathematical option pricing method (Black and Scholes). According to their article, the intrinsic value method should be used at exercise date, because no estimations have to be made, where is referred to a letter of Coopers and Lybrand stating the selection of assumptions has a greater impact on value estimates than the choice of option-pricing models 5. Egginton, Forker and Grout 6 follow the disclosure model and conclude that the company should disclose a set of information, comparable to the inputs of the Black and Scholes model, in order to facilitate investors and auditors to calculate the value of the Employee Stock Options themselves. Concluding the different regulations, theories and practices, an Option Pricing model seems to be generally accepted to estimate the fair value of the Employee Stock Options. Knowing the imperfections of the model, an adjusted model should be developed, whereby the shortcomings of the model are minimized. Tang and Conroy 7 researched practices on corporate disclosures on FAS 123. The finding is that of 150 selected companies 135 companies offered Employee Stock Options. From this group 93 companies disclosed details about valuation. All 93 companies reported according to APB 25 and all 93 companies used the Black and Scholes option model to calculate the fair value of the options. 4 Samuels and Lymer, 1996, pp Coopers and Lybrand, Egginton, Forker and Grout, 1993, pp Tang and Conroy,

26 4.7 Conclusion Neither the National Accounting Boards nor the literature consensus has agreed upon the valuation method of Employee Stock Options. The Financial Accounting Standards Board encourages using FAS 123, which means valuing the Employee Stock Option at fair value using an option-pricing model, but at the same time, the FASB also allows to continue to measure according to APB opinion 25 using the intrinsic value based method. UITF prescribes the use of the non-discounted intrinsic value of share option, in order that share options are treated consistently with share performance plans. IAS and Dutch GAAP do not describe the method to calculate the value of the Employee Stock Options, it is mentioned that fair value should be used if that is possible to determine, otherwise it should be disclosed that it is not practical. So far the international accounting rules do not give answer to the question on how to value the Employee Stock Options. In the literature Samuels and Lymer argue for non valuation other than the intrinsic value method at exercise date where Egginton, Forker and Grout prefer an option pricing model, where the Black and Scholes model has to be modified for the shortcomings in valuing Employee Stock Options. Tang and Conroy concluded that despite the extensive description on how to value Employee Stock Options under FAS 123, not all companies report according to the regulations, particularly because of the immateriality. In my opinion the information to the shareholder should be as clear as possible and the valuation method of Employee Stock Options should be equal. Although the Black and Scholes model has its disadvantages, it is a comparable formula for different companies. The similarities can be increased if the inputs for the model are better described. The volatility should be calculated over a fixed record period, for example the last six months or year of the company stock. The risk free interest rate used in the calculation should also be equal for all companies. A rate determined by the Federal Reserve Bank could be used or the interest rate on 15 year government bonds. Using fixed or well described inputs in the Black and Scholes model where possible minimizes the freedom of calculating the price of the Employee Stock Options. Therefore, I support the idea of Egginton, Forker and Grout that a further improvement of the Black and Scholes model is recommended to minimize the shortcomings of the model in calculating the value of Employee Stock Options. 25

27 5 Recognition date of an Employee Stock Option The recognition of an Employee Stock Option in the accounts can be at different moments in time, depending on the accounting rules and/or theoretical approach. To determine which entries have to be made in the accounts it first needs to be discussed whether the Employee Stock Options are equity or debt. If this question is answered the possible recognition dates are described. The recognition dates described in this chapter are grant date, service date, vesting date and exercise date. 5.1 Is an option Equity or Debt? The issue arises if the option is equity or debt for the company. Because once an equity instrument has been issued it is not subsequently remeasured in the financial statements of the issuer, in contrast with the same instrument being held at a reporting company. If options would be classified as debt, the valuation comes into question because debt is remeasured at the end of the year and equity is not. Remeasuring the option at the end of an accounting year would give disputes on valuation especially when the option is (close to or) at the money and the stock price is very volatile. This can have a reasonable impact on the valuation of the options and therefore to the financial statements. It is most likely that options are equity, because share options do not give rise to transfer economic benefits to another party, like cash or other assets of the entity. If Employee Stock Options are debt, then other options should be recognized as debt as well, which means remeasuring all other forms of share subscription rights on the exercise date. Ordinary shares for example are classified as equity on the basis that the entity is not compelled to transfer assets to the shareholder until some formal act has occurred, such as the declaration of a dividend. The same obligation does not hold true for an option and therefore it can be concluded that an Employee Stock Option is equity. Thus the problem of valuation at the end of the accounting year does not rise. 26

28 5.2 Grant date The grant date is the date that the company makes a commitment to the employee, that under certain conditions, a particular number of options will be awarded. The employer and employee enter into a contract at grant date. The conditions that are part of the contract influence the value of the option. The conditions also influence to what extent the options should be recognized, for example the period that the options are under restrictions and are not exercisable. If the options can be exercised from the grant date, there is no possibility to defend that the costs should not be recognized. The longer the service period, the more unlikely it is that the option will be exercised and the lower the price is. If the exercise price is very high it is defendable that the option will not be exercised in the future, thus it is defendable that no costs are reported yet. Conditions on employee stock option can be: The employee has to remain employed by the company until date vesting date Profit targets or certain growth levels that have to be met over a certain period of time. Pro s Recording should be done on grant date because from this time on the company has an obligation to issue the shares at exercise date, as long as the employee fulfills his or her obligations. The decision to exercise or not is out of the company s hand. When the option contract has a value to the employee, it can be seen as compensation to the employee for the services provided by this employee. If the options were not awarded, the employee would have received another compensation, like a cash payment. If a cash payment is made, it is reported in the income statement as a cost. By awarding options instead of cash, there should also be the same charge to the income statement. Otherwise, it seems that options are an excellent opportunity to reward employees without reporting costs. The market perception still is that free lunches are not available. 27

29 Cons Why should a company account for costs, if costs are not made? By accounting for options on grant date, the costs for options are recorded while it is not sure that these costs are ever really made. The conditions to award the options are not fulfilled yet. The service is not delivered yet and therefore costs should not be reported at this time. If the option has to be accounted for on grant date, it should be possible to value the option. The uncertainties about the value of the options are enormous, especially if options are awarded with an exercise price higher than the actual market price. An out-of-the-money option has a value that is heavily determined by the volatility of the underlying stock and the time to expiration. The valuation can differ heavily at the grant date and it is not sure if the option will ever be exercised, therefore, a valuation later in time makes more sense, because the value can be determined more precisely and less arbitrary. Journal entries If Employee Stock Options are recognized on grant date, an entry into the accounts have to be made in order to show costs in the Profit and Loss account (P&L). The entry to report cost is: Dr Salary costs Cr Stock options to be awarded If the stock options are not bought in the market, the valuation of the balance item Stock options to be awarded is of relevance in presenting a true and fair value of the company. The valuation methods discussed in chapter 4 can be applied if allowed by the national GAAP. If stock options are bought in the market, the relevance of valuation is very low, because of the hedged position. At the time of the purchase of the options the entry is: Dr Stock options Cr Cash 28

30 The balance sheet (BS) items stock options and Stock options to be awarded should balance. Because of this balance, revaluation of stock options (asset) is not necessary to give a true and fair value of the company. The valuation can not have a significant impact on ratios, as there is the debt/equity ratio. Instead of options, the company can also buy stocks in the market, the reasoning is the same, the company is hedging the risk of an increasing stock price. When the options are not bought in the market, the company has an exposure in the stock price of its own company. At the time it becomes clear that the stock options will not come to exercise, because the employee doesn t fulfill his obligations, the entry into the account is: Dr Stock options to be awarded Cr Salary costs This can influence the salary costs in years subsequent to the year in which the options were awarded. If the stock options are bought in the market, they can also be sold in the market. At the expiration date the stock options have to be delivered or an equivalent amount in cash. If the options are bought in the market, the options are transferred to the employee and the entry into the accounts of the company is: Dr Stock options to be awarded Cr Stock options If the options were not bought in the market at grant date, the options have to be bought at this time or an equivalent amount in cash has to be paid to the employee. The entry is: Dr Stock options to be awarded Cr Cash If the company doesn t want to pay by cash but prefers to issue new shares, the employee pays for the shares at the exercise price and the company issues new shares. The entry is: Dr Cash Dr Stock options to be awarded Cr Un-issued stock Cr Stock premium (Agio) 29

31 The stock premium is the difference between the exercise price and the nominal value of the stock, where the nominal value is normally much lower than the exercise price. Here dilution is used to pay off the debt to the employee. 5.3 Service date The service date is the date on which the total services are fulfilled and/or all conditions are met. From the service date onwards, the employee is unconditionally entitled to the option but this does not mean that the employee has the right to exercise the option from the service date. Service date accounting is aiming for the matching principle. Costs have to be recognized over the time that the service is delivered to the company. Pro s On the grant date, there is not a right of the employee to the options, because the performance has not been delivered. On the vesting date the employee has the unconditional right to the option. This right is gained during the service period, and not from one day to the other. Therefore, the service date is preferable to the vesting date, as a matter of the matching principle. Costs are recognized in the time that services have been delivered to the company. The option plan is part of the remuneration to the employees in return for the delivered service by the employees. Depending on the expired service time and the time to the vesting date, a proportional obligation should be accounted for because the company has received the services of the employee. Cons The service period is inappropriate to measure the value of the awarded option and to account for the option, because the value of half an option can not be measured. If the employee has still not fulfilled all his obligations during the service period, the employee has no right at this time. The employee has only fulfilled the obligations to the company if he or she is still employed by the company on the vesting date. As long as all conditions are not met, there is no obligation of the company to the employee and the company should not account for the option only partially serviced. The service date is also inappropriate because a financial instrument is issued on a particular date and cannot be issued progressively over time. 30

32 As mentioned at the grant date, the valuation can differ heavily during the service period and after the service date and it is not sure whether the option will ever be exercised. Therefore, a valuation later in time makes more sense, because the value can be determined more precisely and less arbitrarily. Journal entries During the service period the costs are recognized in the accounts. This can be done in three ways: 1. Buying the options at the grant date and recognizing the costs during the service period, 2. Buying the options in the market during the service period or 3. Recognizing the costs during the service period and taking a provision for the costs at the exercise date. 1. The journal entry when options are bought at the grant date is: Dr Options Cr Cash Recognizing the costs during the service period, the repeating journal entry is: Dr Salary costs Cr Stock options to be awarded At the end of the service period the account Options needs to balance with the account Stock options to be awarded. Upon exercise the journal entry is: Dr Stock options to be awarded Cr Options 2. The journal entries when options are bought in the market during the service period are: Dr Options Cr Cash Dr Cr Salary costs Stock options to be awarded At exercise date the entry is equal to the entry when options are bought at the grant date. 31

33 3. The repeating journal entry when a provision is taken for awarded options during the service period is: Dr Salary costs Cr Stock options to be awarded Here again the company is exposed to risk if stock price increases because the item Stock options to be awarded is not hedged. At the exercise date the entry is: Dr Cash Dr Stock options to be awarded Cr Un-issued stock Cr Stock premium (Agio) To prevent for dilution the company could pay by cash instead of paying with un-issued shares. Then the journal entry is: Dr Stock options to be awarded Cr Cash 5.4 Vesting date The vesting date is the date that the employee has fulfilled all obligations and the employee becomes the unconditional owner of the option. This will not mean that the option can also be exercised from the vesting date on. Typically the right to exercise starts at the vesting date, but it can be that there is a limitation to exercise after the vesting date for a certain period of time. Pro s Until the vesting date the company did not have a liability towards the employee, but from the vesting day forwards the company has a liability. Therefore, the option should be accounted for once the vesting day is reached. The option now has become an absolute right of the employee, to obtain shares at a certain price to be exercised within a specific timeframe. 32

34 Cons The same argument that rises at the grant or service date about valuing the option, is valid for the vesting date approach. It is not sure if the option will ever be exercised. The option can be at the money and very volatile, which means that the value of the option can differ significant in a very short time. Because of this uncertainty it is better to measure and record the value of the option at the exercise date, because then the value can be determined more precisely and less arbitrarily. Journal entries If the recognition date is the vesting date, the date that the employee has fulfilled all his obligations, but the employee is not allowed to exercise or doesn t want to exercise at this date, the entry into the accounts at the vesting date is: Dr Salary costs Cr Stock options to be awarded At the exercise date the entry is: Dr Cash Dr Stock options to be awarded Cr Un-issued stock Cr Stock premium (Agio) The position can be hedged in the period between the vesting and exercise date by buying options in the market. 33

35 5.5 Exercise date The exercise date is the date at which the employee claims the awarded rights. At this time the benefit to the employee is known exactly and the true value of the option is known, because the number of options exercised, the stock market price and the option exercise price are known. Pro s Because only now the true value of the option is known, this is the only moment in time that the actual cost of the Employee Stock Option can be accounted for. If the option is exercised and the employee is awarded with new issued shares, there is no cost recognized. The employee is paid by the shareholders in a way of dilution. The same pie has to be shared by more stockowners. Therefore, reporting on the issued shares and dilution can be done on the exercise day. Cons Charging the cost of the option to the profit and loss account in the year the option is exercised leads to an uneven recognition of cost. There is no match between the service delivered in the reporting period and the cost reported over the same period. The options are gained by the employee in a couple of years and are now charges to the income statement of one particular year. The matching principle is no longer being upheld. The cost made by the company is now depending on the choice of the employee as to when the options are exercised, and even in a more particular way, a manager can influence his result and that of his successor by planning his option exercise. Journal entries When the costs of Employee Stock Options are only recognized at the exercise date the most likely way of accounting is issuing new shares. The entry is: Dr Cash Cr Un-issued stock Cr Stock premium (Agio) There is no charge to salary costs. The cash received is equal to the exercise price and the difference between the exercise price and the market price is not shown. This is only paid by a reduction in the stock premium. 34

36 If the intrinsic value method is used, the difference between the market price and the exercise price (if more than zero) should be recognized and an additional journal entry has to be made: Dr Salary costs Cr Stock premium (Agio) 5.6 Conclusion Like the valuation of the Employee Stock Option also the date of accounting gives many possibilities to defend or attack one date or the other. In the literature more is written about how to value than when to recognize. Harter and Harikumar 8 have discussed the recognition date and defend the recognition at service date in order to match expenses with revenues generated. The international accounting regulations do not offer one best date of recognition for the costs of Employee Stock Options. Under FAS 123 compensation cost is measured at the grant date based on the value of the award and is recognized over the service period. According to APB 25 the measurement date is the first date on which are known both the number of shares that an individual employee is entitled to receive and the option or purchase price. This results in different recognition dates for different plans. Fixed option plans are measured at grant date, while conditional options are measured at service date. If the condition is made of being employed until a certain time, recognition can be done on the vesting date. UITF 17 prescribes the grant date as the date of measuring the Employee Stock Options and the charge should be spread on a basis that reflects the services received. Using the disclosure model, IAS enables the entity to choose the recognition date that suits best. According to IAS the Employee Stock Options can be accounted for on grant date. On the other hand, enabling the company to issue extra shares with only disclosing the fact of granting and exercising, the entity will not have to report the costs in the Profit and Loss account. In this respect Dutch GAAP follows IAS and reporting is done at exercise date. In my opinion the grant date is the date that the company enters into a contract where the company is not in the drivers seat anymore. The company can not influence the outcomes of the contract and therefore the grant date is the appropriate recognition date. From that date on, costs and possible dilution should be reported. 8 Harter and Harikumar,

37 6 G4+1 POSITION PAPER: Accounting for share-based payments. The valuation and recognition problem is also addressed at the International Accounting Standards Committee. Resulting in a Working Group consisting of board members and senior staff of the standard-setting bodies of Australia, Canada, New Zealand, the UK and the US, and the International Accounting Standards Committee (G4+1).The paper s proposals should be developed into new or modified accounting standards, although this can differ between the different jurisdictions. In the discussion paper there is an invitation to comment, set up with questions to the respondents, in order to create the possibility for organizations involved in implementing the Share-based payments to be involved with the standard settings. The possibility to respond has been from the date of publishing (July 2000) until October 31 st, The comments are published on the internet. In total 27 comment letters have been sent to the IASC. The discussion paper deals with the issues mentioned before and makes propositions on the items. The propositions of the discussion paper are described in brief: 6.1 An Employee Stock Option is equity. Liabilities are present obligations to transfer economic benefits or assets to another party as a result of past transactions or events. Equity is defined as the residual interest in the assets of the entity that remains after deduction of liabilities 6.2 An Option Pricing Model should be used to value an Employee Stock Option The discussion paper deals with three measurement methods: (a) historical cost, (b) intrinsic value and (c) fair value. Historical cost is rejected because the historical cost basis does not reflect the value of the options issued or the value of the employee services received. The intrinsic value method is rejected, because options granted are often out-of-the-money and therefore have no intrinsic value, however it is clear that an option has value to the employee. It can be concluded that the intrinsic value does not reflect the option value. Concluding that neither the historical cost nor the intrinsic value is an alternative to represent the value of the Employee Stock Option, the Fair value is the only method left. As method of calculating the fair value, the option-pricing model is found appropriate. 36

38 6.3 Vesting date should be used as recognition date The same systematic approach as used with the valuing of the Employee Stock Options is used to determine the recognition date. The exercise date is inappropriate because of the fact that the Employee Stock Options should be treated as a liability and if the option is treated as a liability it would not qualify for equity, while before it was concluded that an Employee Stock Option is equity. The grant date is inappropriate because of the fact that there is no enforceable right to any party, therefore, there is not a financial instrument. There has been no transfer of assets or liabilities, only a contract has been made, but both parties have not fulfilled their obligation. The service date is not an alternative of recognition, because service date measurement means that the financial instrument is issued progressively over time, while a financial instrument is issued on a particular date. In discussing the other dates, the G4+1 concludes that the vesting date is the only valid recognition date. The vesting date approach is confirmed by the view that at the service date, the services are completed and the owner has the absolute right to subscribe for shares. 6.4 Comment Letters on the discussion paper To structure the comments in the comment letters, the G4+1 listed 15 questions. Among these 15 questions there are particular questions dealing with the issues mentioned before. The comments on the propositions are summarized: An employee Stock Option is Equity. Only question 10 (a) deals with the subject of whether the option is equity or debt, because only when the exercise date is the appropriate measurement date, the question of equity or debt arises. Q10 : If you consider that exercise date is the appropriate measurement date: sub 4 : do you regard a share option as a liability or an equity instrument?, All comment letters agree on the fact that a Stock Option is equity and do not argue that exercise date is the appropriate measurement date. Only a minority of The Japanese Institute of Certified Public Accountants argue that an option is debt 9. 9 CL 25, The Japanese Institute of Certified Public Accountant, December 19,

39 6.4.2 An Option Pricing Model should be used to value an Employee Stock Option Questions three through five deal with the question of valuing the Employee Stock Option. The most vital question is number three. Q3: Do you agree that, where an observable market price for an option does not exist, an option pricing model should be used to estimate the fair value of a share option. Most comment letters agree with the use of an option pricing model. Some comments emphasize the disclosures to be made in order to be able to analyze the calculations made, while others ask for detailed description on the model to be used in order to have a uniform valuation between companies. Frederic W. Cook & Co Inc. 10 argues that fair-value accounting using option-pricing models is controversial and unproven and would not necessarily lead to an improvement in the quality of financial reporting. Therefore, Frederic W. Cook advises to use the disclosure model and the appropriate way of accounting for stock options is calculating the fair value at the grant date disclosing the pro forma effects on net income and EPS. But is there a fair value of the stock options at grant date? KPMG 11 argues that the bargaining process is not comparable to the process of setting a market price and therefore the observable market price is not equal to the fair value of the option: If a disinterested observer finds it difficult to value the elements of the transaction, so too will the parties to it. A significant degree of subjectivity will be involved, and the process will be clouded by specific factors (for example, personal taxation) which are not characteristic of all market participants. And the negotiation may well be between related parties, with all that implies for valuation decisions 10 CL 14, Frederic W. Cook & Co., October 31, CL 26, KPMG, December 20,

40 The International Accountants seem to have more problems with the fair value approach, testified by the comments of Arthur Andersen 12 and Deloitte Touche Tomatsu 13. Arthur Andersen argues that if goods and services are received, this is a better estimate of the value of the options where Deloitte Touche Tomatsu argues that only the financing cost component should be taken into account: Given the subjectivity of the estimate and the inability of the employee to convert the volatility value of the option into cash, we believe the IASC should consider recognizing only the financing cost component of the time value of options granted to employees. While it is not fair value, we believe a traditional option-pricing model also is not fair value in circumstances which the option is prohibited from being sold. Merrill Lynch 14 as well as Shell 15 have comparable comments and prefer only accounting for financing cost. Having read the comments and arguments, it is hard to decide how to value Employee Stock Options. Although I think an Option-pricing model can favor all interested parties as long as all companies use the same model and inputs, so that the income statements of different companies are comparable and the investor knows exactly how Employee Stock Options are valued. This will give more insight than a disclosure model. 12 CL 12, Arthur Andersen, October 31, CL 23, Deloitte Touche Tomatsu, December 8, CL 18, Merrill Lynch, November 9, CL 16, The Shell Petroleum Company Limited, November 7,

41 6.4.3 Vesting date should be used as recognition date Questions six and seven deal with the measurement date. Where question six is concerned with whether the vesting date is appropriate or not; question seven is looking for a better alternative. This statement is not really supported by the comment letters. Out of the 27 comment letters, only one and a half comments (Institute of Cost and Management Accountants in Pakistan and the majority of the Japanese Institute of Certified Public Accountants) agree that the vesting date is the appropriate date for recognizing the Employee Stock Options into the accounts. Two out of 27 comments prefer service date recognition (Enrique Fowler Newton and United States Department of Commerce). KPMG argues that only disclosure is enough and thus the recognition must be at exercise date in the form of dilution. But the majority of the comments argue that grant date is the most appropriate date for recognition. Although it is not the numeric majority that counts, the grant date is the most supported date of recognition. 40

42 7 Employee Stock Options in the Annual Reports To have an insight of how Employee Stock Options are presented in the annual reports of 1999, Twenty annual reports are compared. The comparison is made between companies applying IAS (five) and companies applying respectively US GAAP(five), UK GAAP(five) and Dutch GAAP (five). An overview of applied accounting practices and standards with disclosures is made in appendixes B through E. 7.1 Reporting Employee Stock Options according to IAS A selection of five companies that report according to IAS is: Delhaize (Belgium), Libertel (the Netherlands), Nestle (Switzerland), Teleplan (The Netherlands) and UPM-Kymmene (Finland) Companies applying IAS have a reasonable freedom regarding accounting for Employee Stock Options. IAS requires disclosure of the accounting method applied to Employee Stock Options. A fair value calculation of the options should be disclosed. None of the companies subject to this study discloses a fair value calculation. Delhaize Le Lion S.A. is very brief with the information about awarded Employee Stock Options: For the 1999 financial year, a sum of BEF 37.4 million in fees was allocated to the executive and non-executive Directors. No other remuneration or advantage is associated with the Director s appointment. The difficulty of reporting on Employee Stock Options is easily avoided. Does this mean that Delhaize has all the disadvantages of not having Employee Stock Options? This could be a good proxy to analyze if good management can be attracted and held within the company by Delhaize and if the management acts in its own interest if it is not awarded with Employee Stock Options. Although this will be hard to prove, given the fact that in 1999 Delhaize outperformed the BEL20 and the annual report states: "In recent years, the Board has proposed on its own initiative the reduction of the amount of its share of profit". Maybe cultural differences play a role. 41

43 Libertel N.V. reports in its annual report 1999 three important statements relating to Employee Stock Options: 1) Where Libertel provides long-term employee benefits the cost is accrued to match the rendering of services by the employee concerned. (page 53) 2) In order to reduce potential dilution effects, Libertel s policy for the personeelsoptieplan 1999 is to acquire the required number of shares before or at the moment of exercising the share options. (page 69) 3) At 31 March 2000 no shares were held by Libertel NV or any of its subsidiaries. (page 69) According to the first item, Libertel seems to apply the service date as recognition date, by accruing for possible costs in the future. To prevent for dilution, the shares are bought in the market, but not according to item three listed above. To what amount is accrued for is not disclosed. The risk of dilution is relatively low, the outstanding option rights are 1,523,951 in relation to 1,562,500,000 ordinary shares (0,09 %). Nestlé S.A. is very clear and conservative according the Employee Stock Options. The shares are bought on the stock market at grant date and held until the maturity of the plan or the exercise of the rights. The annual reports states explicitly: No additional shares are issued as a result of the equity compensation plan. The group is not exposed to any additional cost and there is no dilution of the rights of the shareholders. An example of how a mature company should deal with management awards and Employee Stock Options in particular. Teleplan N.V. does not disclose that much information on Employee Stock Options. It is stated that: There are stock option given to the Board of Directors and key management, which does not effect the profit and loss account except for potential taxes. Costs are thus only recognized at exercise date. The risk of dilution is not to be neglected, stock options are granted for 77,000 shares in relation to the outstanding 4,773,859 shares (1.6 %). Number of shares (77,000), Execution terms (3-4 years) and Weighted average exercise price (DM 102,93) are disclosed and Teleplan reports according to IAS but does not inform the investor more than obliged by law. For example what are the conditions to be met for the employees? It is likely that the only condition is to be still employed at the time of execution. What does the Weighted average exercise price give us for information with share options? How many options are far out-of-the-money and how many are in-the-money? 42

44 UPM-Kymmene Oyj. does not disclose much information about Employee Stock Options awarded and the valuing of the options. It is most likely that the options are recognized on exercise date by dilution only. The annual report of 1999 reports: The Managing Director and Deputy Managing Director have additionally received 250,000 share options. Conversion of these convertible bonds and equity options into shares could raise UPM-kymmene Corporation's share capital by EUR 425,455, i.e. by 252,964 shares. The shares would have represented 0.09% of the share capital and 0.10% of the voting rights of the company at 31 December 1999". A more detailed description of the rights and obligations could be expected. 7.2 Reporting Employee Stock Options according to US GAAP Companies that report according to US GAAP are Boeing, General Electric, IBM, John Deere and Yahoo! Inc. All companies report according to FAS 123, using the possibility to report under APB opinion 25, and disclosing the figures as in FAS 123. The Boeing Company Inc. discloses the pro forma net income and earning per share. All detailed information according to APB 25 is given. To calculate the fair value of the awards granted and the potential distribution under the Share Value Trust arrangement, a binomial option-pricing model is used. The assumptions of the model are disclosed. General Electric Inc. (GE) discloses the information required under FAS 123. To calculate the value of the options the Black and Scholes model is used and the assumptions are disclosed. The outstanding stock options are divided into five categories of exercise price ranges: / / 16 ; 25 1 / / 16 ; 40 7 / / 8 ; 72 1 / / 8 and / / 2. But ranges close to at-the-money are more of interest than ranges far out-of-the-money. Because of the changing stock prices the ranges will always be disputable. IBM Inc. grants options at an exercise price equal to the fair market value (at-the-money) of the company s stock at the date of grant. The necessary information is disclosed, and similar to GE, the options are divided in exercise price ranges. The exercise price is divided into four price ranges. The ranges are $10-40; $41-70; $ and $101 and over. IBM uses the Black and Scholes model to calculate the fair value of the Employee Stock Options. 43

45 John Deere Inc. explicitly reports that no compensation expense for stock options was recognized according to APB Opinion 25. For disclosure purpose only under FAS 123, the Black and Scholes option-pricing model was used to calculate the fair values. John Deere uses five price ranges to divide the option exercise prices. Again there is no relation made to options at-themoney or out-of-the-money. The price ranges are: $ ; $ ; $ ; $ and Yahoo! Inc. uses the Black and Scholes model for calculating the fair value of the Employee Stock Options. The company uses nine price exercise price ranges. The ranges are: less than $0.01; $0.02-$0.84; $ ; $ ; $ ; $ ; $ ; $ ; $ No relationship between the possibility of exercise and the price ranges can be made. All disclosures to be made according to APB opinion 25 are made. 44

46 A comparison of assumptions made to calculate the fair value of the Employee Stock Options of companies reporting under US GAAP is as follows: Expected lifetime (in years) of the option granted in the applicable year: Boeing IBM GE John Deere Yahoo / / / Risk free interest rate over the option lifetime awarded in the applicable year: Boeing IBM GE John Deere Yahoo % 6.2 % 6.1 % 6.2 % 5.6 % 6.6 % % 5.1 % 4.9 % 5.8 % 4.2 % % % 6.6 % 5.8 % 4.6 % 4.6 % % Expected Dividend Yield during the option lifetime awarded in the applicable year: Boeing IBM GE John Deere Yahoo % 1.0 % 1.5 % 1.9 % 0 % % 0.8 % 1.8 % 1.6 % 0 % % 0.4 % 1.3 % 2.7 % 0 % 1 Option term is 5 years for tax incentive options and 6 years for non-tax incentive options. 2 No expected dividend yield for the three years ended December 31, The differences in the assumptions are material and especially because the inputs as interest rate and lifetime have a great impact on the value of the Employee Stock Option. A one-to-one comparison is hard to make because of the co-variance of the different factors. But a remarkable difference is that the risk free interest rate is declining over time in the opinion of John Deere where as IBM is expecting an increasing risk free interest rate. Some pre-determined inputs could lead to a more comparable valuation of Employee Stock Options. The Federal Reserve Bank could determine the risk free interest rate over different periods of time and the Security Exchange Commission could determine the volatility more independently than the company itself. 45

47 7.3 Reporting Employee Stock Options according to UK GAAP An at random selection of five companies reporting according to UK GAAP is: British American Tobacco, British Telecom, Glaxo Wellcome, Invensys and Tesco. The disclosures under UK GAAP are more extensive, but beside the prescribed disclosures, the companies report much information about the Employee Stock Options. The exercise period seems to be much longer than under IAS and Dutch GAAP reporting companies. In the UK the options are exercisable from the third year until the tenth year, where under the former mentioned legislations the expiry date was mostly after five years. BP Amoco plc. reports according to UK GAAP with disclosures for US GAAP. There is no disclosure on the fair value of the options granted and the assumptions made. Because of the merger of BP Amoco, the difference becomes clear between the US and UK remuneration and also the factor time. As mentioned in the annual report: In 1998, when shareholders approved the current BP Amoco Share Option Plan, it was considered appropriate to maintain the competitive focus on the oil sector, and it was therefore unnecessary to grant share options to UK directors who participated in the Long Term Performance Plan. Share options were granted in addition to LTPP only to North American directors, as is normal practice in North America. A number of factors have now changed. Further on it is concluded that: ( ) Taking all this into account, the board favours a policy of making a balance of grants under both the three-year LTPP and the longer term share option plan, i.e. following the approach which is currently taken in respect of our US executive directors. The information on how options are awarded is extensive, but the calculation of the value of these options is not available in the annual report but is available for inspection in the company s register of directors interest, as mentioned in a footnote. British American Tobacco plc. (BAT) reports extensively about the remuneration to the management. Three pages in the annual report elaborate on the Employee Stock Options. The information required to be disclosed by UK GAAP is disclosed. Disclosures are made on number of stock options, average grant price, exercise dates and expiry dates. No options or awards over ordinary shares lapsed or were exercised during the year, and therefore no disclosures are made on the number of options exercised and the price at exercise date. All Employee Stock Options are out-of-the-money and have no intrinsic value, thus there is no recognition in the profit and loss account for Employee Stock Options. A calculation is made to reflect the potential dilution if the options of the Employee Stock Options are exercised and consequently shares have to be issued. 46

48 British Telecom plc. (BT) reports under UK GAAP and mentions separately that disclosures to be made under US GAAP are not to be made under UK GAAP. Beside the information to be disclosed BT gives additional information. For example: The weighted average fair value of share options granted during the year ended 31 March 1999 has been estimated on the date of grant using the Black and Scholes option pricing model, also the assumptions are disclosed. To be clear to the investor BT reports: "In accordance with UK accounting practices, no compensation expense is recognized for the fair value of options granted. See United States Generally Accepted Accounting Principles - IV Accounting for share options for the treatment under US GAAP". British Telecom is clear in reporting and has disclosed according to UK GAAP and disclosures are also made to comply with US GAAP. Glaxo Wellcome plc. reports to UK GAAP and discloses the information needed under US GAAP (FAS 123) as well. It explicitly reports that the share options are accounted for as equity when exercised, valued at the issue price. It states: Under US GAAP, equity instruments are required to be valued at fair value and included as compensation in the profit and loss account over the life of the option. To value the options the Black and Scholes model is used, the assumptions made are given. The options granted, exercised and cancelled are clearly reported. Invensys plc. reports according to UK GAAP, but is not very extensive in the information in the annual report. The outstanding options are split in the weighted average exercise price above and below 278.5p. The grant date is not specified. More information is available, but not in the annual report: "Full details of director's shareholdings and options are contained in the Register of Director's Interest which is kept by the company and is open to inspection in accordance with the provisions of the company Act 1985" 7.4 Reporting Employee Stock Options according to Dutch GAAP Five selected companies that report according to Dutch GAAP are: Akzo-Nobel, Boskalis Westminster, Buhrmann, Stork and Unilever. Because Dutch GAAP is in line with IAS, the same regulation applies and the same disclosures could be expected. Also under Dutch GAAP the fair value calculation of the awarded options is part of the disclosures. Only Buhrmann presents such a calculation in the annual report. 47

49 Akzo Nobel N.V. reports Options 1 January Granted Exercised 31 December according to Dutch GAAP. In F.H.J. Koffrie 150,000 40,000 25, ,000 line with IAS the number of G. Dean 60,000 * 25,000 10,000 60,000 R.L. King options granted, exercise price F.F. Waller ,000 45,000 35, ,000 and exercise date are reported. * Of which fictitious The options expire after five years and may not be exercised during the first three years. There is no statement made about costs, therefore, it can be concluded that these options are only calculated for the purpose of dilution. Conditional and Unconditional options sum to 1,799,552 options in relation to the weighted average number of outstanding shares of 285,441,344 is a possible dilution of 0,3 %. No costs are recognized in the profit and loss account. Boskalis N.V. is quite clear about the accounting for Employee Stock Options. Grant date, vesting date, exercise date, the number of options outstanding and the exercise price are reported. In 1999 no option rights were granted. Shares bought in the market cover all option rights. The report discloses: "By the purchase of 500,000 share certificates (1998: 100,000) during the year under review for an amount of 7.4 million (1998: 1.5 million) and with the nominal value of 1.1 million (1998: 0.2 million) dilution resulting from stock dividend was prevented. These purchases have been charged to Other reserves. Of these purchases 178,964 share certificates were issued as stock dividend". It can be concluded that the surplus of shares bought is to cover the option rights to prevent for dilution as well. Burhmann N.V. gives a table with options, and in the text underneath it can be read that the Members of the Supervisory board held another 215,000 rights of which were awarded at the end of These options are held by Mr. Kluis who received the option rights in place of remuneration for the period during which he temporarily assumed chairmanship of the Executive Board. About these option rights no disclosure is given about exercise date, exercise price and vesting date. As a footnote to the table it is stated that Mr George Dean holds fictitious option rights, without disclosing how to account for these fictitious options. A fictitious option scheme prevents for the issuance of new shares and a charge is made to the profit and loss account at exercise date of the fictitious option scheme. 48

50 The disclosure Buhrmann makes about the fair value calculation is the use of the Black and Scholes model and the assumptions made are: Expected dividend yield: 3.70% Expected Price fluctuation 40% Risk-free interest rate 4.89% Expected term 4 years These assumptions were used exclusively for this calculation and do not necessarily provide an indication of expectations of company management regarding developments in the future. The result of the calculation is that the market value of the option rights assigned would have given a net result of EUR 1 million lower for both 1999 and After reading this annual report it is hard for an investor to determine the influence of the Employee Stock Options on the profit and loss account in 1999 and the years coming. Particularly because of the awarded options to Executive Board, the fictitious options of Mr Dean and only disclosing the assumptions, but not the calculated amount of the fair value calculation. Stork N.V. discloses the information on the outstanding option rights. The disclosures made are year of granting, year of termination of the exercise right, number of outstanding rights and exercise price. The vesting date is not disclosed. The options are not accounted for yet and the company reports the effects of dilution. It is reported as follows If the still outstanding 603,500 option rights, of which 215,000 are held by the Board of Management are exercised, the issued share capital will increase by EUR 3 million and shareholders' funds by EUR 16 million. 49

51 Unilever N.V. reports according to Dutch GAAP but also discloses information if this is obliged under UK GAAP because of the double heading of the company. The report is extensive on reporting Employee Stock Options. Shares to cover the obligations are bought at grant date and are kept until exercise date. The calculation base for granting is disclosed, but the fair value calculation, according to UK GAAP and Dutch GAAP is not reported. A table gives insight in option rights by person, with separated options that are in-the-money and out-of-the-money. Unfortunately a sum of all outstanding option rights is not given. Another complicating factor is that the awarded option rights can be either on the UK listed shares or the Dutch listed shares. For both the information is disclosed, but it does not create transparency for the shareholder. 7.5 Conclusion As concluded in chapter three, there are significant differences between reporting according to IAS and the three national accounting practices subject to this study. From this chapter it can be concluded that also significant differences exist between companies reporting in accordance with the same accounting principles. In my opinion, Nestlé S.A. is most prudent in reporting on Employee Stock Options and I doubt if the shareholders of UPM-kymmene Oyj. have any idea of how much is awarded to the employees with Employee Stock Options and what the cost to shareholders are, as a matter of dilution (depending on the exercise price). The information might be available to the shareholder upon request at the company, but the annual report does not provide the shareholder with the information. 50

52 8 Conclusion Accounting for Employee Stock Options is far from harmonized all over the world. The IASC leaves too much interpretation to national accounting practices or does not give enough guidance on how to account for Employee Stock Options. Disclosures have to be made in every jurisdiction, but the disclosures differ significantly. Under US GAAP the disclosures are most extensive, under UK GAAP the rules are less strict and under IAS and Dutch GAAP the disclosures are minimal. Not in any of these accounting practices or standards disclosure has to be made about possible future dilution. The first sub-question How to value Employee Stock Options? is discussed in chapter four. The conclusion of chapter four indicates that fair value valuation is preferable above the other methods of valuation, although the valuation itself should be improved. The Black and Scholes model is a good starting point but needs to be adjusted for the characteristics of the Employee Stock Option. The inputs of the option valuation model need to be better described, because by determining the inputs of the model, the outcome can be influenced significantly. In chapter five the second sub-question is discussed, When to recognize Employee Stock Options in the accounts?. The conclusion of chapter five is that the recognition date preferred is the grant date. From the grant date on, the company enters into a contract where the company is not in control of the outcome anymore. For an auditor it is hard to test whether the management has made an unbiased opinion about the value of the employee stock options. It is also hard to justify that no costs are reported during the lifetime of the option and hardly costs are reported upon exercise. I think it is unavoidable to take the Employee Stock Options into account and not only report them as a disclosure. The G4+1 advises the fair value calculation using an option-pricing model that suits the company best. As the recognition date, the vesting date is proposed. The comments agree mostly on the fair value calculation, as well as support the grant date instead of the vesting date as the appropriate recognition date. 51

53 Because of the listing at different stock exchanges, bigger companies report according to the national GAAP of the seat of the company and disclose information needed in the countries of listing. International integration of accounting standards would make the annual accounts of different companies more transparent and this also applies to the valuation of Employee Stock Options. 52

54 Literature Articles Bernhardt, W., (1999), Stock Options For or Against Shareholder Value? New compensation plans for top management and the interest of the shareholders, Corporate Governance: An International Review, Vol. 7, No. 2, pp Braam, G.J.M. and J. Dijksma, (1999) Opties voor de verwerking van personeelsopties, Tijdschrift voor Bedrijfsadministratie, September, pp Egginton, D., J. Forker and P. Grout, (1993), Executive and Employee Share Options: Taxation, Dilution and Disclosure, Accounting and Business Research, Vol. 23, No. 91a, pp Gamble, R.H., (1999), An Ounce of Prevention, Business Finance, August, p. 27 Harter C.I. and T. Harikumar, (1998), A new approach to Account for Stock Option Compensation, Internet, not published yet. IASC, Accounting for Share-based Payments, (2000), Accounting Standard Board and G4+1, Discussion paper No. 18. Klasssen K.J. and A. Mawani, (2000), The Impact on Financial and Tax Reporting Incentives on Option Grants to Canadian CEOs, Contemporary Accounting Research, Vol. 17, No. 2, pp Lewellen W., T. Park and B. Ro, (1995), Executive Stock Option Compensation: The Corporate Reporting Decision, Managerial and Decision Economics, Vol. 16, pp Matsunaga, S.R., (1995), The Effects of Financial Reporting Costs on the Use of Employee Stock Options, The Accounting Review, Vol. 70, No. 1, pp.1-26 Reingold J. and R. Grover, (1999), Executive pay, special report, business week online, April 19, Internet. 53

55 Sacasas R.,and P. Munter, (1998), Who is an employee: some implications of SFAS No. 123, The CPA Journal, June, pp Samuels J. and A. Lymer, (1996), The Financial Reporting of Executive Share Options in the UK, British Accounting Review, Vol. 28, pp Scully, M., (2000), Share-based Payment, Radical new proposals from ASB, Accountancy Ireland, October, pp.12. Tang R.Y.W. and S.A. Conroy, (1998), FAS 123: A Further Look at Corporate Disclosures on Employee Stock Options, The Journal of Corporate Accounting and Finance, Summer, pp Newspapers Financial Times, November 9, 2000, Bringing share options to book: The Accounting Standards Board has the arguments to win its fight over the treatment of employee stock schemes. Het Financieele Dagblad, October 31, 2000, Personeelsoptie in jaarrekening blijft worsteling. Het Financieele Dagblad, August 17, 2000, Technologiesector lijdt stilletjes optiepijn. Het Financieele Dagblad, May 13, 2000, Europa worstelt met zijn optiebeloning. Het Financieele Dagblad, April 17, 2000, De Nederlandse optiemythe: geen kosten, geen risico s. Forbes Magazine, 18 May 1998, Stock Options are not a free lunch. 54

56 Regulations IAS International Accounting Standards, IAS 19 Standing Interpretation Committee, SIC 16 US GAAP Statement of Financial Accounting Standards, SFAS 123 Accounting Practices Board, APB 25 UK GAAP Companies Act 1985 Urgent Issues Task Force, UITF 13 Urgent Issues Task Force, UITF 17 Dutch GAAP Richtlijnen voor de Jaarverslaggeving, 2000, Richtlijnen voor de Jaarverslaggeving, 2000, KPMG, Global Accounting: UK, US, IAS and the Netherlands compared, KPMG Accountants NV, second edition, December 2000 PriceWaterhouseCoopers, International Accounting Standards, Similarities and Differences, IAS, US GAAP and UK GAAP, February 2000 Coopers and Lybrand, Letters to Financial Accounting Standards Board, February 5th 1993 and December 29th

57 Annual Reports IAS Delhaize Le Lion S.A. Libertel N.V. Nestlé S.A. Teleplan International N.V. UPM-kymmene Oyj UK GAAP BP Amoco plc British American Tobacco plc British Telecom plc Glaxo Wellcome plc Invensys plc US GAAP Boeing Inc. General Electric Inc. IBM Inc. John Deere Inc. Yahoo! Inc. Dutch GAAP Akzo Nobel N.V. Koninklijke Boskalis Westminster NV Buhrmann NV Stork NV Unilever NV Comment Letters on the Discussion paper: Accounting for Share-based Payment CL 1: Robert Jones (Hong Kong) CL 2: Enrique Fowler Newton (Argentina) CL 3: Richard Macve, London School of Economics (UK) CL 4: Föreningen Auktoriserade Revisorer FAR (Sweden) CL 5: Institute of Cost and Management Accountants in Pakistan (ICMAP) CL 6: John Flower (Germany) CL 7: National Venture Capital Association (NVCA) (USA) CL 8: Institut der Wirtschaftsprüfer (IDW) (Germany) CL 9: United States Department Of Commerce, Bureau of Economic Analysis (BEA)(USA) CL 10: Association of Publicly Traded Companies (APTC) (USA) CL 11: Veijo Riistama, Helsinki School of Economics and Business Administration (Helsinki) CL 12: Arthur Andersen (International) CL 13: Foreningen af Statsautoriserede Revisorer (FSR) (Denmark) CL 14: Frederic W Cook & Co (USA) CL 15: Association for Investment Management and Research (AIMR) (USA) CL 16: Shell Petroleum (Netherlands) CL 17: PricewaterhouseCoopers (International) CL 18: Merrill Lynch (USA) CL 19: International Association of Financial Executives Institutes (IAFEI) CL 20: Raad voor de Jaarverslaggeving (Council for Annual Reporting) (RJ) (Netherlands) CL 21: British Bankers' Association (BBA) (UK) CL 22: Barclays (UK) CL 23: Deloitte Touche Tohmatsu (International) CL 24: Fédération des Experts Comptables Européens (FEE) CL 25: Japanese Institute of Certified Public Accountants (JICPA) CL 26: KPMG (International) CL 27: DRSC German Accounting Standards Committee (GASC) (Germany) 56

58 Appendix A The value of Employee Stock Options Employee Stock Options are not traded on the option market, but are over the counter products, without the possibility of transfer. A market value is therefore not available. For some Employee Stock Options, there is a comparable option available in the market with the possibility of transfer, but what adjustments should be made for valuing the transferability? For options not traded in the market, the Stock Option Valuation Method of Black and Scholes is often referred to. The Black and Scholes model recognizes the following parameters as influencing factors of the option value: - Exercise price of the option - The current market price of the stock - The expected volatility of the stock price - The dividends expected to be paid on the shares - The market interest rate - Life time of the option (time to expiration) The Black and Scholes formula C = S N(d 1 ) Ke (-rt) N(d 2 ) C = theoretical call premium e = exponential function ( ) S = current stock price d 1 = {ln(s/k) + (r + δ 2 /2) t }/ δ t t = time until option expiration d 2 = d 1 - δ t K = option striking price (Exercise price) δ = standard deviation of stock returns r = risk-free interest rate ln = natural logarithm N = cumulative standard normal distribution Parameters that influence the value of the Employee Stock Option, but are not taken into account in the Black and Scholes option model are: 57

59 - Time to vesting date. To become unconditionally entitled to the option, the employee must fulfill some conditions. For example the employee must remain employed by the company for a certain period of time. These conditions can be very diverse and cannot be accounted for in a general model. But the uncertainty of the condition to be met, have a negative influence on the value of the option. - Time to exercise right. An Employee Stock Option can have a period between vesting date and the date of the exercise right. Although the owner of the option is unconditionally entitled to all rights of the option, he or she is not allowed to exercise the option until a specified date in the future. The time of no exercise right has a negative influence on the value of the option. - Non-transferability. Employee stock options are not freely tradable, but are personal. This condition has a negative influence on the value of the option. These limitations of the model make a general acceptance of the calculation method for Employee Stock Option disputable. 58

60 Appendix B Overview of companies applying IAS Requirements of IAS UPM-Kymmene Oyj Libertel NV Teleplan NV Delhaize Le Lion SA Nestlé SA Valuation method Fair value X X X X X X Intrinsic value Market value Historical cost Forecast growth Recognition date Grant date Service date Vesting date Exercise date X X X X X X Disclosures made Fair value X Intrinsic value Number of shares under option X X X X Number of options granted X X X na Number of options exercisable X X Number of options exercised X X X Options outstanding beginning of the year X X X na Options outstanding end of the year X X X X na Number of shares issued Stock price at grant date Number of shares bought in the market Exercise date X X Exercise price X X X Expected lifetime of the options Expiry date X X X Expected Volatility of the underlying stock Expected dividends Risk free interest rate X Nature and Terms Accounting Policy X X Dilution effect X X X X Costs charged to P&L X X 59

61 Appendix C Overview of companies applying US GAAP Requirements of FAS 123 Boeing Inc General Electric Inc IBM Inc John Deere Inc Yahoo! Inc Valuation method Fair value X X X X X X Intrinsic value Market value Historical cost Forecast growth Recognition date Grant date Service date Vesting date Exercise date X X X X X X Disclosures made Fair value X X X X X X Intrinsic value Number of shares under option X X X X X X Number of options granted X X X X X X Number of options exercisable X X X X X X Number of options exercised X X X X X X Options outstanding beginning of the year X X X X X X Options outstanding end of the year X X X X X X Number of shares issued Stock price at grant date X Number of shares bought in the market Exercise date X Exercise price X X X X X X Expected lifetime of the options X X X X X X Expiry date X X X X X X Expected Volatility of the underlying stock X X X X X X Expected dividends X X X X X X Risk free interest rate X X X X X X Nature and Terms X X X X X Accounting Policy X X X X X X Dilution effect X X X Costs charged to P&L X X X 60

62 Appendix D Overview of companies applying UK GAAP Requirements of UK GAAP BP Amoco plc British American Tobacco plc British Telecom plc Glaxo Wellcome plc Invensys plc Valuation method Fair value X X X X X X Intrinsic value Market value Historical cost Forecast growth Recognition date Grant date Service date X X X X X X Vesting date Exercise date Disclosures made Fair value Intrinsic value Number of shares under option X X X X X X Number of options granted X X X X X X Number of options exercisable Number of options exercised X X X X X X Options outstanding beginning of the year X X X X X X Options outstanding end of the year X X X X X X Number of shares issued X Stock price at grant date X na X X Number of shares bought in the market X Exercise date X X X X X Exercise price X X X X X X Expected lifetime of the options X X Expiry date X X X X X X Expected Volatility of the underlying stock X X Expected dividends X X Risk free interest rate X X Nature and Terms X X X X X X Accounting Policy X X X X X X Dilution effect Costs charged to P&L X 61

63 Appendix E Overview of companies applying Dutch GAAP Requirements of Dutch GAAP Akzo Nobel NV Boskalis NV Buhrmann NV Stork NV Unilever NV Valuation method Fair value Intrinsic value X X X X X X Market value Historical cost Forecast growth Recognition date Grant date Service date Vesting date Exercise date X X X X X X Disclosures made Fair value X X Intrinsic value Number of shares under option X X X X X X Number of options granted X X X X X X Number of options exercisable X X Number of options exercised X na na X X X Options outstanding beginning of the year X X X X X X Options outstanding end of the year X X X X X X Number of shares issued Stock price at grant date X Number of shares bought in the market X X X Exercise date na na Exercise price X X X X X X Expected lifetime of the options X X Expiry date X X X X X X Expected Volatility of the underlying stock X X Expected dividends X X Risk free interest rate X X Nature and Terms X X X Accounting Policy Dilution effect Costs charged to P&L X 62