It was only a few flicks of the calender away, it was as recently as 2004, that one could say that generally accepted accounting principles (GAAP) in the United States didn't require employers to recognize in the books they showed the investing public that by issuing stock options to their employees they were incurring an expense.
The move of the FASB that year toward standards explicitly requiring this was caught up in the election-year debates. The FASB held its ground, although if I remember correctly it had backed down under political pressure on the same score a decade before. But the second time around it held its ground and made the expensing of stock options mandatory for all annual and interim reports, effective beginning June 15, 2005.
Over the last few years the nature of the debate has shifted. Now that we know companies are supposed to expense their stock options, the question is: how?
There are three dominant methods thus far. There's the Black-Scholes-Merton (MSN)formula, the Monte Carlo os 'simulation' methods, and the lattice model.
The lattice model is the most intriguing of the three in my eyes so I'll expound upon that a bit.
The modelers start by dividing the time between the issuance of an option and its expiration into a definite number of discrete time periods. These periods might be, for example, months or quarters.
Given input variables and assumptions that the company and its modelers must makle explicit, they can then assign a probability to an "up" and to a "down" move in each period. This yields two (or more, depending on how the particular lattice is constructed) end points, which are then starting points (nodes) for the next jump.
The model continues to generate nodes in an ever-widening pattern, looking a bit like a branching tree turned on its side (because the horizontal axis by convention represents the passage of time) until time runs out; that is, until option expiration.
Modelers then employ the whole lattice to decide what would be the value of an option in the final time segment. It helps that the ending is in a sense binary. Either the exercise price of the option is less than the current stock price or it is not, and that simplicity makes calculation straightforward. From there, one can work backward, step by step, until one comes eventually to a value for the option at time 0.
Showing posts with label stock-based compensation. Show all posts
Showing posts with label stock-based compensation. Show all posts
Sunday, August 8, 2010
Wednesday, August 4, 2010
EBITDA and Stock-Based Compensation
The acronym "Ebitda" is in the news again.
For the record, this stands for "earnings before interest, taxation, depreciation and amortization," and is sometimes thought a useful statistic as an approximation of cash flow.
Over time, the significance once attributed to the P/E ratio has come to be relocated -- the value/EBITDA ratio is now the important one.
Value, for such purposes, is a modification of the simpler statistic of market cap, or price.
So: why do I bring it up today? Because it is in the news, of late. Two listed companies, Penson Worldwide (NASDAQ: PNSN) and Comtech Telecommunications (NASDAQ: CMTL) have been called out on fiddling with their EBITDA calculation.
Penson has added stock-based compensation into the EBITDA figure, while Comtech has addedf the amortizationof stock-based compensation. Well ... the A does stand for amortization, but not as it happens that amortization.
Of course, if the EBITDA figure itself can be jiggered with in this way, then any ratios of which EBITDA forms a part become less useful for any investors who might be relying on them. If an investor is diligently working out the value-to-EBIDTA ratio, he'll end up with a smaller ratio that he "should" for these firms. Smaller, that is, than he would if the rules were adhered to consistently. That smaller ratio might well lead him to include, "these stocks are at bargain prices."
Sam Antar has done good work bringing these shenanigans to public notice, and I congratulate him on that.
Another way of looking at this story, though is as a new episode in a continuing controversy over how to account for stock-based compensation. On that, I hope to have something to say next week.
For the record, this stands for "earnings before interest, taxation, depreciation and amortization," and is sometimes thought a useful statistic as an approximation of cash flow.
Over time, the significance once attributed to the P/E ratio has come to be relocated -- the value/EBITDA ratio is now the important one.
Value, for such purposes, is a modification of the simpler statistic of market cap, or price.
So: why do I bring it up today? Because it is in the news, of late. Two listed companies, Penson Worldwide (NASDAQ: PNSN) and Comtech Telecommunications (NASDAQ: CMTL) have been called out on fiddling with their EBITDA calculation.
Penson has added stock-based compensation into the EBITDA figure, while Comtech has addedf the amortizationof stock-based compensation. Well ... the A does stand for amortization, but not as it happens that amortization.
Of course, if the EBITDA figure itself can be jiggered with in this way, then any ratios of which EBITDA forms a part become less useful for any investors who might be relying on them. If an investor is diligently working out the value-to-EBIDTA ratio, he'll end up with a smaller ratio that he "should" for these firms. Smaller, that is, than he would if the rules were adhered to consistently. That smaller ratio might well lead him to include, "these stocks are at bargain prices."
Sam Antar has done good work bringing these shenanigans to public notice, and I congratulate him on that.
Another way of looking at this story, though is as a new episode in a continuing controversy over how to account for stock-based compensation. On that, I hope to have something to say next week.
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