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ESO may have a dramatic impact on the size of the spread. While
the exercise price is fixed at the grant date, the value of the
stock is not fixed until the ESO-holder exercises the option.
This personal decision is based on the employee’s liquidity
needs, aversion to risks, and other miscellaneous factors. In
essence, the market and ESO-holder, rather than the contracting
parties, determine the size of the spread and when the spread
will be incurred. Simply put, rational profit-maximizing
unrelated parties would not cede this control over costs or be
willing to accept such a high degree of uncertainty relating to
costs.
In short, the value of petitioner’s stock, and thus the
potential size of the spread relating to ESOs, could rise and
fall in line with the vicissitudes and vagaries of the market.
The semiconductor industry, of which petitioner is a prominent
member, may be particularly subject to these types of market
swings and trends. Thus, the spread is affected by a myriad of
factors and calculated and incurred at a point in time when the
contracting parties have no control over the amount.
Finally, we note that sharing the spread could also create
perverse incentives for unrelated parties. One of petitioners’
experts, Mukesh Bajaj, stated:
A well-designed economic contract would ensure that
both partners have an incentive in seeing the value of
the other partner rise. If * * * the Spread * * * has
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