The valuation of employee share options for accounting purposes: is IFRS 2 on target?

This paper investigates the valuation of employee share options (ESOs) for accounting purposes. As a result of ESOs differing from normal traded options, it is often contended that ESOs cannot be valued reliably for accounting purposes. The paper demonstrates that sufficient academic literature is available to support the fact that ESOs can be valued reliably using an option-pricing model of one form or another. The paper also points out the quintessential distinction between company cost of ESOs and the value of the ESOs to the executive. Because of the different risk profiles of the executive and the company, the value of the ESO to the executive will differ from the value to the company. The objective when valuing ESOs for accounting purposes is to value the ESO from the company's perspective (that is, the company cost), rather than from the executive's perspective. The paper proves that the recently issued International Financial Reporting Standard 2 (IFRS 2) accords with the findings of this paper and is therefore academically sound.