Learn how New Constructs models Employee Stock Options using the Black-Scholes model to calculate their hidden liability. The tool adjusts ESO expenses for years before 2006, when companies weren't required to report them, then subtracts the fair value of outstanding options from cash flow projections and book value.
Chapters
Welcome to the New Constructs tutorial for our Employee Stock Option, or ESO, page within our stock valuation models. To access the ESO page, generate a stock valuation model and click the Financials and Metrics tab. Then click ESO on the blue ribbon. The ESO page details our calculation for the company's annual ESO expense and the company's outstanding ESO hidden liability. First, we detail our calculation for the company's annual ESO expense. The annual ESO expense is an adjustment that impacts years prior to 2006 in our model. Prior to 2006, companies were not required to record any expense for issuing ESOs. Many companies exploited this accounting loophole by compensating their employees with ESOs, which led to overstated earnings. We no longer make a NOPAT adjustment for this expense because in 2006, the Financial Accounting Standards Board recognized this accounting loophole and started requiring companies to record expenses related to ESOs. At the bottom of the ESO page, we outline our process for calculating the company's hidden liability for all outstanding ESOs. Employee stock options don't just affect the current profitability of a company. They also represent a hidden liability based on future share dilution as employees exercise their options and add to the total number of shares Outstanding. We use the Black-Scholes model to account for the fair value of all ESOs outstanding and subtract this value from the present value of future cash flows in our discounted cash flow model and economic book value calculation. Thanks for watching this tutorial. If you have any questions, please leave a comment.
