Designing Robust Stock Option Plans

Abstract

With the introduction of the accounting standards FAS 123 and IFRS 2 for executive stock options an important change towards fair value accounting' has taken place. As companies are now forced to value their stock options at grant date for accounting purposes, the robustness of prices against misspecifications of the valuation model has become a very important issue. We address this issue by first analyzing certain building blocks of existing stock option plans with regard to their robustness properties. Based on such an analysis, we show as the main contribution of the paper how robust stock option plans can be designed. The resulting stock option plans are both transparent in structure and reasonable in respect to the incentives they provide in order to increase shareholder value. This paper therefore concludes that stock options can be reliably expensed, if the corresponding plans are properly designed.