Valuation of Employee Stock Options and Other Equity-Based Instruments

On March 31, 2004, the Financial Accounting Standards Board (FASB) published an Exposure Draft (ED) on accounting for equity-based compensation. This ED requires that firms expense ESOs and provides guidance as to how they should be valued. This report summarizes the new valuation guidelines and provides commentary, where appropriate, including potential implications for firms. FASB's preferred binomial valuation model is outlined in detail. Also discussed are the differentiating features of ESOs and the potential impact the new guidelines may have on the design of equity-based instruments.