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After reviewing both experts’ methodologies, we conclude
that Black-Scholes is a more credible stock option valuation
method than the Growth Model. Unlike Mr. Rowley’s Growth Model,
Black-Scholes accounts for the effects of dividends and
volatility on the stock options’ values. Moreover, generally
accepted accounting principles support the use of Black-Scholes
for valuing stock options. For example, paragraph 19 of SFAS No.
123 requires for financial reporting purposes that companies use
a fair value method of accounting, such as Black-Scholes, to
estimate the companies’ stock option expenses.47 Furthermore, we
disagree with petitioners’ contention that Black-Scholes
understates the options’ values. Considering that Black-Scholes
does not account for transfer restrictions, vesting periods, or
the risk of forfeiture, Black-Scholes more likely overstates the
options’ values.
In support of Dr. Hakala’s decision to alter the Black-
Scholes value by taking a 50-percent discount for risk aversion,
respondent cites articles in accounting journals that describe
the valuation approach of SFAS No. 123 and discuss the prevalence
and implications of forfeiture and early exercise of employee
47Paragraph 19 of SFAS No. 123 actually recommends a
slightly modified version of Black-Scholes in that the SFAS No.
123 model replaces the actual-time-to-expiration variable with
the expected life of the option. In paragraph 169, SFAS No. 123
explains that this substitution reflects the restrictions on
transferability of employee stock options.
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