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A Proposal for Expensing Employee Compensatory Stock Options for Financial Reporting Purposes

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  • Peter Hancock
  • Roberto G. Mendoza
  • Robert C. Merton

Abstract

This article presents an accounting approach for employee stock options based on the insight that the currentperiod compensation expense should reflect only that part of the option value that is earned independent of the obligation of continued employment. Given that the maturity of "vested" options is typically shortened to 90 days when an employee resigns or is terminated, this method views the employee as owning a 90-day option (even if the stated maturity of the option is ten years) and earning a 90-day extension to that option each quarter as a result of the employee's continued employment. In the case of vested options, the compensation expense in each quarterly accounting period is thus the value of the 90-day extension of the option's maturity. There is no option expense in the quarter when the option is either exercised or expires. 2005 Morgan Stanley.

Suggested Citation

  • Peter Hancock & Roberto G. Mendoza & Robert C. Merton, 2005. "A Proposal for Expensing Employee Compensatory Stock Options for Financial Reporting Purposes," Journal of Applied Corporate Finance, Morgan Stanley, vol. 17(3), pages 95-101.
  • Handle: RePEc:bla:jacrfn:v:17:y:2005:i:3:p:95-101
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    1. Miller, Merton H, 1977. "Debt and Taxes," Journal of Finance, American Finance Association, vol. 32(2), pages 261-275, May.
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