Accounting may derail market for employee stock options
The decision on accounting treatment could spell the difference between success or failure for Esoars, or employee stock option appreciation rights securities, a new financial product offered by Zions, a Salt Lake-based bank holding company. Esoars buyers don't get options, but an instrument whose value depends on the stock price, the options price, and whether employees exercise their options.
Stock options, which give holders the right to buy company stock in the future at a preset price, typically are valued using pricing models designed for exchange-traded stock options. Questions about valuing employee stock options have become more pressing as companies now must deduct the cost of options they grant. Securities and Exchange Commission Chairman Christopher Cox has encouraged competition and innovation, dismaying critics who think market experiments will yield low-ball valuations of employee stock options.
While critics have focused on whether auctions are a valid way to value stock options, a sleeper issue is how to account for such financial instruments, a seemingly technical question that could make or break the market for such products.
"We are in talks with FASB to try to get our Esoars instruments treated as equity," said Zions vice president Evan Hill.
Deeming such products to be equities would be the best possible result for Zions, although it may delay trading until 2008. However, if standard-setters decide such products are a liability, they likely would be categorized as derivatives, dealing a one-two punch that could boost costs and volatility and raise valuation questions anew, making the tracking instrument far less appealing to companies looking for new ways to value employee stock options.
The reason: derivatives must be marked to market, generally each quarter. While the accounting for employee stock option grants wouldn't change under such an approach, companies would have to reassess any tracking instrument used in valuing those options. That might require frequent auctions, or reverting to options-pricing models, defeating the purpose of using Esoars-type products. Another downside is that as a liability, any increase in the value of the tracking securities would be treated as an expense, reducing earnings.
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