Accounting & Tax

SEC Approves Market-based Options Model

The approach produces what "may be a real number" versus the "hypothetical numbers" of models currently in use, the commission's chief accountant r...
Stephen Taub and Dave CookJanuary 30, 2007

Zions Bancorporation announced that it has received approval from the Securities and Exchange Commission to value employee stock option grants using a market-based approach.

“We strongly believe that among the several available methods for option valuation, a fair and open public auction of an appropriately designed tracking security is the best way to obtain the fair market value of employee stock options,” said executive vice president W. David Hemingway, in a statement.

It may also be a good way to polish Zions’s bottom line. Employee Stock Option Appreciation Rights Securities (ESOARS), as Zions has named them, may enable the financial services company to assign a lower value to its stock options than if it used a traditional approach such as Black-Scholes. That lower expense, in turn, would mean a smaller impact on earnings.

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Most public companies were required to expense options as of their first fiscal year that began after June 15, 2005, the effective date of the Financial Accounting Standards Board’s rule FAS 123R. Many companies — especially in the technology industry, which had tended to rely more heavily on options for compensation — complained that existing methods such as Black-Scholes model produced too high a value for options, and too big a hit to earnings.

In May 2005, Cisco Systems proposed selling a new derivative that would rely on market forces to price its options. That September, SEC chief accountant Donald Nicolaisen said in a statement that he had “significant doubts” about the possibility of designing an instrument that would achieve the goals of 123R. The commission ultimately withheld its approval.

Approval for Zions’s market-based approach came late last week in a letter from the current SEC chief accountant, Conrad Hewitt, reported The Wall Street Journal. Hewitt reportedly wrote that an auction system could be used to derive “market” values for employee stock options and that market-based approaches produce what “may be a real number” versus the “hypothetical numbers” produced by models currently in use.

Zions also announced that it has a patent pending on its ESOARS design and market-pricing mechanism, and that it intends to advise other public companies on how to use its model.