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June 2017 | Issue 86 Background Constellis Group,  Inc. is a private security firm.  In December 2013, the Company formed an Employee Stock Ownership Plan (“ESOP”), which purchased 100% of Constellis’s voting stock.  Wilmington Trust NA was named Trustee of the ESOP.  Less than a year after the ESOP was created, the ESOP sold all […] More...


March 2017 | Issue 85 Introduction Richard and Steven Parker are brothers who ran a flower business in Scotch Plains, New Jersey.  Richard is the President of Parker Interior Plantscapes (“PIP”), which installs and services plants and flowers in commercial settings.  Steven is the President of Parker Wholesale Florists (“PWF”), which is a garden center.  […] More...

Dell Appraisal Spawns a Multitude of Valuation Approaches

February 2017 | Issue 84 Introduction A Delaware Chancery appraisal case involving computer company Dell Inc. gave rise to a multitude of valuation measurements.  It is instructive to see how the court sorted through them in coming up with its final appraisal conclusion.  The case is In re Appraisal of Dell Inc., 2016 Del. Ch. LEXIS […] More...

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Market-Based Stock Option Valuations Receive SEC Blessing

February, 2007 | Issue 14

The SEC Speaks SEC Chief Accountant, Conrad Hewitt, in a January 25, 2007 letter, said that an auction market approach designed and tested by Zions Bancorporation may be used as a basis for valuing employee stock option awards for purposes of expensing these awards for financial reporting purposes under FASB Statement 123R.

Zions’ Market Test
In June, 2006, Zions conducted a public on-line auction of a new security called an ESOARS (Employee Stock Option Appreciation Rights Security). The ESOARS are a tracking security designed to mimic the economic payout that an investor would receive were he to invest in a representative sample of a certain underlying group of Zions Bancorporation employee stock options. Investors in ESOARS receive payments on the ESOARS in an amount proportional to the amount that the employees receive from exercise of their options. A detailed description of ESOARS can be found at www.ESOARS.com.

Zions conducted this test because it felt that the most widely-used option valuation models being currently employed to value employee stock options, the Black-Scholes-Merton model and the matrix model, don’t totally faithfully replicate the unique economics of employee stock options. Therefore, these models shouldn’t be relied upon alone to provide an accurate measure of the fair value of employee stock options. Zions believed that if they could expose to the marketplace a security that more faithfully shadows real employee stock options, then the market would yield up a price that more accurately represents the true fair value of the underlying options.

What Happened?
Zions conducted their ESOARS auction on June 29, 2006. It was conducted on the Internet as a Dutch auction, similar to a Treasury bond auction, except that the bids were open rather than sealed. The auction was held open for 30 hours. There were 57 bidders who made a total of 1,041 bids. The winning price determined by the auction was $7.50 per ESOARS unit. One ESOARS unit corresponds to one employee stock option. Winning bidders purchased 93,610 units, resulting in $702,000 of proceeds.

How Does This Compare to Black-Scholes-Merton?
Using the Zion stock price on the auction date, the Zion employee stock options underlying the ESOARS would have been worth $12.65 per option, according to the Black-Scholes-Merton model. Adjusting for pre-vesting forfeitures, the ESOARS auction produced a corresponding value for the same options of $8.57 per option. In short, the market measure produced a value that was 32% lower than the academic model measure.

The SEC Urges Care
The SEC, in its letter, while acknowledging that ESOARS are “sufficiently designed to be used as a market-based approach” to value, recommended that each ESOARS auction be analyzed to make sure that its clearing price is representative of the fair value of the underlying options. Factors to be considered should include the size of the offering relative to the market, the number of bidders, and the bidders’ perception of the costs of holding, hedging or trading the instrument.

What Does All This Mean?
If future ESOARS auctions continue to produce market-measured values for employee stock options that are lower than those produced by academic models, we can expect to see a lot of enthusiasm in corporate America for using the market measures, as this will reduce the compensation expense that must be recognized when options are issued. Widespread acceptance of market measures will, of course, also require a buy-in by the FASB and the auditing profession.