tailieunhanh - Valuing Employee Stock Options Part 4

Chapter 4: Haircuts on Nonmarketability, Modified Black-Scholes with Expected Life, and Dilution. ESOs are neither directly transferable to someone else nor freely tradable in the open market. | 4 Haircuts on Nonmarketability Modified Black-Scholes with Expected Life and Dilution NONMARKETABILITY ISSUES ESOs are neither directly transferable to someone else nor freely tradable in the open market. Under such circumstances it can be argued based on sound financial and economic theory that a nonmarketability and nontransferability discount can be appropriately applied to the ESO. However this is not a simple task as will be discussed. A simple and direct application of a discount should not be based on an arbitrarily chosen percentage haircut on the resulting binomial lattice result. Instead a more rigorous analysis can be performed using a put option. A call option is the contractual right but not the obligation to purchase the underlying stock at some predetermined contractual strike price within a specified time while a put option is a contractual right but not the obligation to sell the underlying stock at some predetermined contractual price within a specified time. Therefore if the holder of the ESO cannot sell or transfer the rights of the option to someone else then the holder of the option has given up his or her rights to a put option . the employee has written or sold the firm a put option . Calculating the put option and discounting this value from the call option provides a theoretically correct and justifiable nonmarketability and nontransferability discount to the existing option. However care should be taken in analyzing this haircut or discounting feature. The same inputs that go into the customized binomial lattice to calculate a call option should also be used to calculate a customized binomial lattice for a put option. That is the put option must also be under the same 41 42 IMPACTS OF THE NEW FAS 123 METHODOLOGY risks volatility that can change over time economic environment riskfree rate structure that can change over time corporate financial policy a static or changing dividend yield over the life of the option contractual .