Fasb backdating stock options
Figuring out exactly what the value of the option is today, before the option vests and before the expiration date, is more difficult.One has to estimate the probability of a future gain and the timing of a future gain, and it makes sense to come up with a standard way of estimating today’s value.At issue were options on derivatives, not employee stock options, but Freddie Mac’s problems suggested potential future manipulation of employee stock option reporting.Freddie Mac’s officers arbitrarily decided that volatility calculated based on the then current market prices did not reflect fair value.Berkshire Hathaway offered to pay a substantial cash sum to any executive granted a restricted stock option in exchange for the right to any future gain the executive might realize. Buffett trained a spotlight on the fact that employee stock options are a real cost of doing business.
The Binomial model was more flexible for doing scenario analyses on corporate earnings and assessing risk, but I was still concerned about the potential for corporate officers to manipulate the system.
Instead, it used historic prices as the basis on which to calculate volatility when it revalued its options.
The result was astounding; Freddie Mac eliminated 1 million from its 2001 accounting transition adjustment gain (through adoption of a new accounting rule, SFAS133) by choosing an opportunistic methodology for determining volatility.
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It is very simple to figure out the value in three years, and the options have a positive value today since it gives the employee the right to a potential gain tomorrow.