Firms Divided Over Calculating Cost

One of the biggest issues companies face in deciding whether to expense the cost of stock options is that there is no agreement on how best to calculate that cost.

The ultimate cost of an option, after all, is unknown--it will depend on how the stock performs in the market and how many options are exercised by executives and other employees.

Under current accounting standards requiring companies to footnote in financial statements the estimated cost of their options, the rules say companies must estimate the fair value of options using the so-called Black/Scholes method or another acceptable method.

The Black/Scholes method is named for Fischer Black and Myron Scholes, economists who in 1973 developed a formula for valuing traded stock options.

Their method incorporates such factors as the historic volatility of the stock involved, the level of market interest rates and the expected life of the option.

But some companies don’t believe the Black/Scholes method is necessarily the right valuation method.

General Motors Corp. last week said it would begin expensing options in 2003, but it pointedly said that “current valuation methods available for expensing options are not ideal.” The company urged regulators to come up with a standard plan that is “more accurate.”

Billionaire Warren Buffett, who has been pressing corporate America to expense options, likes Coca-Cola Co.’s approach: Coke plans to ask Wall Street investment banks to say how much they’d pay for the company’s outstanding options, and use that value in determining their cost.

Others say that isn’t fair. Because employee stock option contracts aren’t tradable, it’s unrealistic to ascribe to them a value (and therefore, a cost) as if they were tradable, some critics say.

Scholes, in a recent interview with Bloomberg News, said he has grown tired of people attacking the Black/Scholes method of estimating option values.

“We never said that the model should be used only as it was illustrated,” he told Bloomberg. “The technology can be used and modified to take account of changes in vesting or volatility. You have to adjust things.”