The SEC has nixed the new Cisco employee stock option I blogged back in May. Cisco would have used institutional sales of the security as a method of determining a value for it, thereby reducing the cost of the option for purposes of the new SEC rule requiring companies to expense the value of options granted to employees.
The commission’s Bureau of Economic Analysis rejected the idea of selling restricted options to institutional investors, as Cisco had proposed, and using their value to estimate the value of the options issued by the company.
It said that many of the restrictions, like barring an employee from transferring the option or hedging its value though trades in other securities, could affect their value to the employee but not the cost to the company issuing the options. And, it said, it is the company’s cost that is supposed to be measured.
Applying such restrictions, the economists said, “to the design of a market instrument will not yield a transaction price that measures the cost of the option grant to the issuer and, this, will not meet the fair-value- measurement objective of the standard.”
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Under the rule approved by the Financial Accounting Standards Board, companies have considerable discretion in using valuation formulas to estimate the value of the options when they are granted. But some companies have argued those formulas overstate the actual value of the options, and have looked for ways to reduce the value. The lower the value that is calculated, the higher reported earnings will be.
It looks like the SEC has left the door open to the possibility of other market-based techniques of valuing the options, so we may hear more from this story in time.