Stock Option Analysis for the 2003 Treasury Regulations on Cost Sharing
24 Pages Posted: 5 Jan 2004
Date Written: October 11, 2003
The US Treasury has issued revised regulations, under section 1.482-7, that require taxpayers to include costs associated with stock-based compensation in cost pools for fiscal years starting after August 26, 2003. The new regulations' impact on cost pools due to inclusion of employee stock option costs, how taxpayers may consider responding to the choice of method for valuing options required by the new regulations, and the difference between Black-Scholes and exercise date option valuation, are the foci of this paper. The size of the increase to a given cost pool will depend on factors outside the taxpayer's control - such as the stock price in the future - as well as on choices made by the taxpayer - such as whether to utilize the elective measurement method offered in the new regulations. In this paper I have formalized the taxpayer's decision on elective measurement. I have shown, very generally, that choosing the elective grant date measurement method will not be optimal for taxpayers. This is because most taxpayers that qualify for the elective method currently use some version of Black-Scholes method to disclose the estimated fair values of options. Under general circumstances, the Black-Scholes method will result in expected cost pool additions 36% to 59% greater than using the default method of valuing options upon exercise.
Keywords: Tax, transfer pricing, cost sharing, treasury regulations, employee stock options, Black-Scholes, pricing, section 482, measurement, fair value, stock option, option, valuation
JEL Classification: D21, D46, D81, F00, G13, H25, K34
Suggested Citation: Suggested Citation