Maxim Integrated Products, Inc. along with other organization has implemented expensing employee stock options as required by FASB Statement 123(R). The issue presented is whether expensing employee stock options under fair value rules accurately reflect the company’s true financial condition and what would be an appropriate way to assess the company’s performance when valuing the its stock. Case Data
Maxim Integrated Products, Inc. designs, develops, manufactures, and markets a broad range of linear and mixed-signal integrated analog circuits. It. granted stock options to its employees in order to give them the right to buy a specific number of shares of the company stock at the price the company specified at the time of employment. This is a form of compensation made my Maxim that enabled them to keep their financial performance and to attract top notch engineers employees by offering compensation that goes beyond one’s salary. Stock option compensation is important for Maxim as it attracts and retains top qualified employees and help to boost the company’s productivity. In addition, by using stock option compensation Maxim maximizes the value to its shareholders by reducing the expense for employee compensation. Under the new rules the company won’t be able to reduce the expense for employee compensation as it will be required to expense the options. The new requirements would have an effect on the way employees are compensated but will still remain a primary motivational and recruiting factor for most high-tech companies. Any changes in the form of compensation would still need to be expensed whether it is cash based or restricted stock grants and should not have a significant effect on the net income.
In the past the company had expensed employee stock options using the intrinsic value method, which recognized stock options compensation costs as the difference between market and exercise prices of the options at the grant date. Under the intrinsic method the company did not recognize expense for the stock options issued with an exercise price equal or less to the stock’s price at the grant date. The effect on income of the stock options was only disclosed as part of the financial statement notes. Under the FASB Statement 123(R) the company is required to start expensing stock option grants using the fair value method in the quarter that they are incurred. If stock options were expensed during the previous years, the expense as percentage of the net income for the company was going to be 45% for 2003, 34% for 2004 and 28% for 2005. Expensing Stock Options: FASB vs. APB25
The FASB issued the Statement 123(R) that indicated that their preferred recognition of the fair value of employee stock options as an expense item starting in the year of grant along with wages, salaries, bonuses and other similar cash items. What this means and the goal here is to calculate the stock option expense based on determining the value of the employee stock options on the date of the grant. They recommend achieving this goal by utilizing the Black-Scholes option pricing model or the binomial model. Both methods allow significant latitude in valuing the options by changing a set of assumptions for the expected holding period, interest rates, stock price volatility and the dividend yield. Any changes in the assumptions used will result in different value used for expensing the stock options at their grant date.
Previously, despite the recommendation made by the FASB, Maxim elected to follow the APB 25 accounting standards or the intrinsic value based method which is basically the difference between the current price of the stock and the strike price. This means that Maxim allowed their employees to purchase stock at a discounted price or at the price at the time employees were employed. Therefore, if the employee was to exercise the stock option and the discount...