Under IFRS, employee share options are required to be expensed at fair market value. This is derived using mathematical models sanctioned under the accounting standards. However, even with very sophisticated models, some companies argue that the expense generated is still higher than the true value of options. But the only way to prove this is to create employee share options that have an immediate market value based on trades between buyers and sellers.

Last September, the US equivalent to ASIC, the Securities and Exchange Commission (SEC), rejected Cisco’s proposal to issue exchange-traded employee options. At that time, the SEC stated that it was open to other ideas about how market instruments could be used to value employee options (and the SEC’s Office of Economic Analysis even suggested two alternatives, although the SEC’s Chief Accountant expressed scepticism about whether companies would quickly embrace them).

In early June, the Wall Street Journal ran an article that Zions Bancorp planned to register securities that would mimic employee stock options for public auction – and the price fetched at auction would become a “market” value for the securities that the company could use to determine the expense it must book for awarding options to its employees. To the best of our knowledge we do not believe the registration statement has been filed yet.

Here is an excerpt from the article:

“Buyers of the securities receive payments from Zions when employees exercise their options. If the options expire worthless or aren’t exercised by employees, holders of the securities receive no payments and lose the entire value of their investment. Essentially, Zions is creating what looks and feels like a so-called asset-backed security, with the underlying asset in this case being the options. The bank expects high-net-worth individuals and sophisticated investors to buy the securities. Among other things, these investors would be betting Zions’ stock would continue to rise and thus push Zions employees’ options “into the money.”

The bank hopes the auction will produce a truer – read: lower – value for employee stock options than would be derived from valuation methods such as Black-Scholes, the standard formula that has been used for years. That would happen, Zions argues, because investors would take into account factors unique to each company’s employee options program that aren’t reflected in most pricing models.”

It will be interesting to see if the SEC will approve Zions’ method – one key difference from Cisco’s rejected proposal: Zions will sell the securities at the highest, “market-clearing” price it receives at the auction rather than sales through private placements (as per the Cisco model). And if the SEC approves Zion’s deal, it remains to be seen whether there will be enough competition among bidders to ensure a real market emerges. If it does, this could be an interesting avenue to consider for Australian companies that believe options pricing methods as applied to employee share options hit their bottom line too hard. Australia’s derivatives market is, like the USA’s, quite sophisticated and growing rapidly, so this alternative to current fair market value methods seems quite feasible.

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