Robust stock option plans

Abstract

The main purpose of this paper is to address the issue of robustness of stock option plans, which is essential for reliable accounting valuations. The introduction of the accounting standards SFAS 123R and IFRS 2 for executive stock options has led to an important change. As companies are now forced to value their stock options at grant date for accounting purposes, the robustness of prices against the choice of certain valuation models and input parameters 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 our analysis, we then show how robustness of stock option plans can be achieved. 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. We therefore conclude that stock options can be reliably expensed, if the corresponding plans are properly designed.