An Empirical Analysis of Stock Option Valuation Methodologies in Closely Held U S Corporations

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Universal-Publishers, 2009 - Business & Economics - 128 pages
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The introduction of fair value accounting for stock options has required private companies to apply stock option valuation methodologies that were designed to be applied to their public counterparts. The two recommended methodologies, the Black-Scholes formula and the Binomial Lattice model, require the valuator to provide an input for estimated volatility; for private companies that do not have a trading history there is limited guidance regarding the determination of volatility, which results in diverging and incorrect estimates. Based on a sample representing 178 companies who filed and completed an IPO in 2006, this study analyzed the accuracy of the recommended valuation methodologies when applied to closely held US corporations. The study outlines the importance of volatility to the value of the options and proceeds to document, by comparing the private (pre-IPO) and public (post-IPO) data, that in 51% of the cases the volatility was either over- or under-stated by more than 10%. In addition, the study shows a bias towards overstatement in the less than 10% variance group. The study further demonstrates that a marginal change in volatility has a significant impact on the company's total stock-based compensation expense and consequently misstates earnings.
 

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Contents

CHAPTER 2 Impact of incorrect valuation
37
Taxation
38
On the Grantor
39
SECTION II FRAMEWORK
41
SFAS 123
42
SFAS 123R
43
Compensation Costs
44
Forfeiture
45
Current Practice
77
SECTION III ANALYSIS
83
CHAPTER 6 Expected Results
85
For the sample
87
Experiment Design
88
Sampling
89
Limitations
90
Measurement
91

SOX 404 internal controls
46
CHAPTER 4 Taxation
48
Nonqualified Stock Option Plans
49
409A
51
Illiquid Startup Assumption
52
Binding Formula Presumption
53
CHAPTER 5 Valuation
54
BlackScholes
55
Application
61
Limitations
62
Lattice Models
63
Application
67
Limitations
68
Volatility
69
Importance
71
CHAPTER 7 Data Analysis
92
Distribution Analysis
94
Correlation and Regression
96
SECTION IV CONCLUSIONS
98
CHAPTER 8 Main conclusions
100
Expectation for the population
101
CHAPTER 9 Outlook
104
More professional guidance
105
Require professional valuations
106
CHAPTER 10 Further research
107
Bibliography
109
Appendix I Sample prior to exclusions
113
Appendix II Sample after exclusions
119
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