Cisco's New Option

Michael Mandel

I always thought that most of the people who favored expensing stock options really would be happier just getting rid of them. Now, with Cisco's latest proposal for valuing options, we'll find out if I was right.

Cisco has proposed issuing securities that would have most of the characteristics of employee stock options--i.e. they would be options on the company's stock, but they would take time to vest and they would be difficult or impossible to trade. Then the market price of the securities would represent the true value of employee options, which in turn would determine the amount that Cisco has to expense.

In theory, using the market to price employee options in this way is far superior to using Black-Scholes or any other rule. If the people who favor expensing stock options really just wanted to make the accounting better, they would leap at Cisco's proposal.

However, the market-based approach is likely to put a lower value on stock options than Black-Scholes, precisely because the new securities won't be tradeable and will take time to vest--maybe a much lower value. That's why I predict that the pro-expensing crowd will come up with plenty of technical reasons why Cisco's proposal won't work, despite its superiority. The real motive for expensing options was to drive companies away from offering stock options, not make it easy for them.

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