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Option And Warrant Valuation

Overview: There are multiple methods that can be used to value a stock option or a warrant. Companies will often utilize low-cost valuation techniques such as traditional Black-Scholes-Merton (“BSM”) to value these instruments. As the FASB puts more standards in place such as ASC 718, Stock Compensation (pre-codification Statement of Financial Accounting Standards No. 123(R)), it is becoming obvious that although BSM is a low-cost method, it is not the preferable method for valuing these instruments since the technique permits only one input for each variable in the model. There are other valuation techniques which have inputs to value the credit risk, interest risk, probability of exercise, risk of dilution and other risks that are embodied in these instruments.

Other valuation methods which may be better suited to value options and warrants include Modified Black-Scholes methods (which account for additional risk assumptions compared to the traditional Black-Scholes Method), Binomial or Trinomial Lattice methods and Simulation models. Not only are these valuation techniques often preferable from the FASB and SEC’s point of view since they contain additional valuation assumptions, but they often result in a lower expense for the company.

Services: We have extensive experience applying various valuation techniques to options and warrants. We often provide our clients with calculations of fair values using various types of valuation techniques to determine the most appropriate method of measuring fair value. Our fair value calculations are always prepared under Statements on Standards for Valuation Services, published by the AICPA and we provide our clients with the necessary journal entries.

Case Study: A company had used the traditional Black-Scholes technique to value their stock options in the prior quarter. The traditional BSM model did not embody all of the risk and assumptions surrounding the options. We reviewed alternative (and preferable) valuation methods and ultimately identified an alternative technique that, when properly applied, resulted in a compensation expense of approximately $2,600,000 rather than $3,800,000. Since a change in valuation technique is not considered a change in accounting principle, the company was not required to obtain a preferability letter from their auditor.