A Note on the Measure of Compensation Implicit in Employee Stock Options

Abstract

For more than twenty-five years, the measure of compensation which resides in employee stock options has been the subject of controversy in the accounting profession. The long-standing position of the American Institute of Certified Public Accountants is to recognize compensation expense to the degree that the market price exceeds the subscription price of the shares under option as of the date the option is formally granted to the employee.! Since 1964, stock option plans which qualify for favored treatment under the Internal Revenue Code require that the subscription price be not less than the market price, obliging the accountant, in the case of qualified plans, to recognize no compensation at all. Even under nonqualified plans, the measure of recognized compensation expense is determined by a spread which may, in actual fact, bear little relation to a reasonable estimate of the compensation involved. One solution, advanced by Sweeney in 1960, is to use the cash value of the employee's services, to the extent that they are unremunerated by an actual cash payment, as the measure of the amount of compensation ex2 pense. Alternatively, one might judge the amount of expense by reference to the value given in exchange. In 1961, Campbell suggested such an approach. He proposed, first, that the company's present share price be extrapolated to