Using Auctions to Price Employee Stock Options: The Case of Zions Bancorporation ESOARS
43 Pages Posted: 5 Mar 2007
Date Written: August 14, 2007
To estimate the grant-date expense of their employee stock options (ESOs), as required under the new accounting rules (FAS 123R), companies have typically had to choose among various theoretical valuation models because there is no secondary market for ESOs. Different models, all permissible under FAS 123R, produce widely different values, raising questions about the efficacy of the new rules. We study an alternative market-based scheme, recently proposed by Zions Bancorporation, in which options are valued by means of an online auction of securities (ESOARS) that track the aggregate payments made to the reference ESOs. Zions has conducted two ESOARS auctions, under somewhat different rules (in June 2006 and May 2007). We investigate whether the auctions represent an effective, arms-length approach to the pricing of ESOs - as indicated by bidders' demand elasticity and a comparison of the auction prices to various model-based estimates. Despite legitimate concerns about size and seller incentives, we find that the auction mechanism appears quite resilient in terms of delivering fair values of ESOs. In particular, the 2007 auction - with rules that, for instance, reduce incentives to delay bidding ('snipe') - produced a value similar to those generated by models that explicitly consider the historical pattern of employees' early exercise decisions (e.g., Bajaj et. al. (2006)). Policy and other implications of our findings are discussed as well.
Keywords: auctions, employee stock options, financial reporting
JEL Classification: G10, G13, G18, D44
Suggested Citation: Suggested Citation