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Scholes model (BS model), for purposes of measuring the value of
ESOs. The BS model was originally designed to measure publicly
traded options and, as a result, fails to adequately take into
account numerous differences between ESOs and publicly traded
options. For example, ESOs are nontransferable and have terms to
maturity that are usually longer than those of publicly traded
options. The extended term of an ESO complicates the task of
estimating the volatility of the stock price, which is an
essential input in the pricing of any option. Furthermore, ESOs
cannot be traded, so they must be discounted to account for the
difference in value between tradeable and nontradeable options
(i.e., tradeable options are worth more than nontradeable
options). Yet, the appropriate discount is difficult to
determine with reasonable accuracy because the discount is based
on the value of the ESO to an employee. Moreover, an ESO’s value
is affected by whether an employee forfeits the option by failing
to exercise it or exercises the option prior to the expiration of
the ESO’s maximum life. These employee decisions cannot be
reliably modeled. Thus, FAS 123 requires companies to make
certain adjustments to take into account the differences between
ESOs and publicly traded options. For example, to account for
option forfeiture, SFAS 123 requires that an ESO’s value be
discounted to reflect the amount of forfeitures expected
annually. With respect to early exercise, the expected life of
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