Almost 80% of the ASX 300 companies have in place an existing employee or executive share option plan. In the annual financial reports so far published since June 30 2004, all the companies with an executive option plan have disclosed the annualised fair value in executive remuneration tables more or less in accord with the Australian Accounting Standards Board (AASB) 1046 standard. But many of these companies have not specified the details for valuing employee equity compensation. The valuation method details are required to be disclosed as part of Australian’s adoption of international accounting standards (in particular, IFRS 2) from January 1 of 2005, and are detailed in AASB 2. From this point, at a minimum, companies are required to disclose the following inputs into, and outcomes from, employee share option and rights valuation:
• Estimated fair value of each share option or right granted;
• Method used to estimate fair value (e.g. a binomial option pricing model);
• Model input value of the share price at grant date;
• Grant date;
• Model input value of the exercise price;
• Model input value of the expected volatility and how this volatility was determined;
• Model input value of the expected dividends;
• Model input value of the contractual life of the option;
• Model input value of the risk-free interest;
• Model input value of the early exercise assumptions; and
• Model input value of the share price volatility and its basis.
If the option valuation model was a more complex lattice model using more variables, then more model inputs may need to be disclosed.
Companies have, so far, tended to state the method used, but we have been surprised at the proportion of companies that fail to disclose the values of all material variables.
Guerdon Associates readily acknowledges there is currently a very limited knowledge and skill base in Australia for option valuation. Given the liability issues, directors on the audit and compensation committees probably need to take affirmative action to verify that their company complies with these new standards.