Floyd Norris writes that the SEC is considering allowing firms to expense their employee stock options using valuations from a small-scale auction run by Zions Bank.
Early auctions have yielded values way below Black-Scholes and other methods. Norris is skeptical that these auctions are just a trick to help companies underexpense their options. He quotes Stephen Ross (whom I took asset pricing from at MIT), who worries that the auction values are essentially bid prices, and if the market is illiquid, bid prices may understate value.
Obviously, what Zions wants to do is not that far from running a prediction market. Frankly, it’s a pretty clever idea.
Two thoughts:
1. If others read the article and have the same reaction I do (i.e., where do I sign up to build a portfolio of these underpriced options?), the underpricing from the early auctions may become less pronounced.
2. Of course, if the underpricing is the main reason companies want to run the auctions in the first place, that could kill the idea. So Zions has a strong incentive to set things up in a way that produces low valuations (e.g., restricting access or bid sizes). For this reason, Norris is probably right to be skeptical, but you might imagine some requirements the SEC could impose that would partially alleviate these concerns.
Addendum: Zion’s site is here.
Sounds similar to Google’s employee stock option market. http://www.msnbc.msn.com/id/16184123/
The ESOARs and the Google transferables are interesting ideas.
In my view, the ESOARS are a good faith idea of how to predict the “Fair Value” of ESOs at grant day.The “Fair Value” is the FASB and SEC costs to the firm of the options granted.
The “Fair Value” is not the “theoretical value” of any ESOs to a recipient, because the ESO holder can manage his options to increase their value by staying at the firm longer than avearge and refusing to make premature exercises.
Anyone can participate in the ESOARS auction and buy large or small amounts. The ESOARS can be re-sold to any willing buyer.
It is difficult to get a precise value because the “Fair Value” depends on what decisions the holders of all the options make as far as premature exercises and longevity at the firm.
The latest ESOARS price was auctioned at 12.07. with the strike being 83.25 and 7 years life. I believe that the price should have been 13.5-14.5, so the value was underprised by 2 pointsi in my view.
The fact that there is very little trading in the listed calls on Zion Bancorp means that there are few hedging opportunities. Therefore the bidders would have difficulty selling listed calls as hedges. This discourages a higher auction bid.
If Zion’s can get other companies to try its plan, there may be some opportunities to buy the ESOARS and hedge by selling listed calls. I do not see much opportunity in the initials Zion offering but there could be more comming.
On the other hand, the Google Transferables is a scam created by Morgan Stanley and its aligned associates to profit from uninformed holders of the Google TSOs.
The TSOs offer no substantial benefits benefits to Google employees unless they are in financial straights, especially those who understand how options work.
The TSO holders could merely hedge their ESOs by selling the same listed calls that the Mofgan Gang of Four woud sell. They would save”time premium” and delay their taxes far into the future.
Nor does Google get a benefit from the transferables.
John Olagues