Faithin Omaha eBook Collection

Download or read book The Impact of Dilution on the Value of Employee Stock Options written by Pascal Paul Prinz and published by . This book was released on 2006 with total page pages. Available in PDF, EPUB and Kindle. Book excerpt: This thesis investigates the issue of actual or potential dilution of an employee stock option issue. Dilution may affect existing shareholders as well as holders of stock options. With the accounting rule change in 2005 requiring companies to expense the fair value of employee stock options at grant date the debate about appropriate valuation methods to estimate the fair value of employee stock options has intensified and also includes the question of whether a dilution correction is necessary when valuing stock options. This thesis identifies two situations where an estimate of dilution may be needed. First, a company contemplating an issue of employee stock options may want to investigate its dilutive effect before realizing it. Second, a nonpublic company may need to apply a dilution correction to estimated option values since there is no stock price which reflects actual or potential dilution of employee stock options. This thesis presents methods which are based on a multiple options approach for dealing with the above two cases. Furthermore, it is shown that leverage may increase the dilutive effect of employee stock options due to the higher risk, i.e. return volatility, leverage introduces to the company. The latter finding underlines the importance of a reliable estimate of the volatility of equity when valuing employee stock options. Additionally, evidence suggests that the volatility may not be constant, questioning the use of valuation models which assume a constant volatility for valuing employee stock options.