Autumn 2016


Thought Leadership in the Valuation of Options, Warrants, Grants, and Rights

Editor for This Issue: Robert P. Schweihs
Stock Option Valuation Insights

Thought Leadership:
The Economic Analysis of Real Option Value
Robert P. Schweihs
The discounted cash flow method does not always completely capture the uncertainty of the future financial performance of a business, business ownership interest, or security that is the subject of a valuation analysis. In those instances, when the valuation purpose should take into consideration the owner/operator’s ability to influence the future financial performance of the subject investment, then real option valuation (ROV) theory is a powerful analytical tool. ROV analysis is often used by corporate acquirers—and by other investors— who are more interested in the question “what is this investment worth to me?” than they are in the question “what is the market value of this investment?”

Valuing Derivative Securities and Share-Based Compensation for Marital Dissolution Purposes
Robert P. Schweihs
As an asset of the marital estate, derivative securities and share-based compensation are subject to special consideration. Restricted stock, stock appreciation rights, and employee incentive stock options often require some future event to occur before those security interests vest. And, once vested, those security interests are often subject to restrictions on transferability. Various important dates (employment, grant, vesting, exercise, expiration) affect the value of these securities to the marital estate. Valuation analysts should be aware of the unique characteristics of these securities and of the effect of such characteristics on the value to the marital estate.

Overview of Stock-Based Executive Compensation Plans for ESOP Sponsor Companies
Kyle J. Wishing
This discussion provides an overview of stock-based executive compensation plans for ESOP sponsor companies. More specifically, this discussion provides (1) a basis for installing stockbased executive compensation plans at ESOP sponsor companies, (2) an introduction to the types of stock-based incentives that are commonly used by ESOP sponsor companies, and (3) an overview of the best practices for implementing a stock-based executive compensation plan for ESOP sponsor companies.

Valuation Practices and Procedures Insights

Guidelines for the Third Analyst in a Three-Analyst Valuation Process
Robert P. Schweihs
Both shareholder contracts and shareholder controversies often call for three valuation analysts to participate in the ownership transition valuation of the subject business, business ownership interest, or security. Private company security buy/sell agreements often use this three-analyst process. And, disputing parties in shareholder oppression, dissenting shareholder appraisal rights, and other breach of fiduciary duty controversies often turn to the three-analyst valuation process in order to resolve their differences. How the threeanalyst process works in each situation is determined by either the shareholder (or other) contract or the agreement of the parties. This discussion recommends guidelines both to valuation analysts—and to other process participants—involved in a three-analyst business/ security valuation process.

Measuring Equity Volatility for Closely Held Company Securities
Patrick O. Van Dyke and Benjamin H. Groya
Valuation analysts may use option pricing models to estimate the fair market value of stock options. This discussion focuses on the implied volatility estimate within the Black-Scholes- Merton (BSM) option pricing model. Specifically, this discussion (1) highlights the procedures that valuation analysts may use to estimate implied volatility, (2) observes the impact that implied volatility has on stock options for closely held companies, and (3) addresses factors that can change that implied volatility.

Best Practices
A Closer Look at Volatility in Stock Option Valuations
Fady F. Bebawy
Volatility is considered by many valuation analysts to be an important input in performing stock option valuations. Estimating volatility can be complex. This is because the analysis involves perspectives that at the same time (1) may result in different or conflicting indications and (2) may be interrelated and overlapping. This discussion summarizes three perspectives the analyst may consider in estimating volatility and presents insights and guidelines that may aid the analyst through the analysis.

Tax Valuation Insights

Valuing Stock Options in Compliance with Section
Reid L. Chanon
Internal Revenue Code Section 409A provides the income tax provisions related to deferred compensation—including employee stock options. Section 409A does not prescribe a universal methodology to value employee stock options. However, many analysts apply option pricing models—such as the Black-Scholes option pricing model (“Black-Scholes”) or a binomial model—to value employee stock options. This discussion provides (1) a summary of Section 409A and (2) an overview of common option pricing models.

Intellectual Property Insights

Intellectual Property Valuation, Damages, and Transfer Price Analyses
Robert F. Reilly, CPA
The analyst should be aware of the context in which the analysis is prepared. For example, most intellectual property valuation standards require that the analyst define certain conditions under which the analysis is relevant. These conditions include the use of the analysis and the intended users, the intellectual property being analyzed, the standard of value and the premise of value, and the effective date of the analysis. In a different context, many of these conditions can be different and those differences may render the conclusions of the analysis irrelevant. In a different context, the report describing the analysis conclusion may be considered irrelevant. This is because that report doesn’t explain the analytical approaches within the appropriate context. This discussion considers different types of intellectual property, different contexts for analyzing intellectual property, and different intellectual property valuation, damages, and transfer price methods.