Valuing Employee Stock Options for a Corporate Merger

Gnarus Advisors LLC expert Ron Rudkin was retained by a worldwide gaming company to determine the fair value of its outstanding employee stock options (EDOs). The valuations, which were required to consummate a merger with another firm, were challenging because of the large number of complex features of the ESOs being valued.

The ESOs in this case study had features that were different from those of the instruments typically awarded by the firm, including stock prices that are no longer “at-the-money,” market-based mechanisms, accelerated vesting and time-varying inputs, which cause the models traditionally used to value ESOs (Modified Black-Scholes and Hull and White) to produce incorrect results. By using the Gnarus Equity and Stock Option Valuation (ESOVAL) models instead of the traditional models, Dr. Rudkin was able to produce fair value estimates that were more accurate and significantly lower than those produced by traditional models.

The Gnarus ESOVAL models are a suite of sophisticated lattice-, Monte-Carlo simulation-based and Quasi-Monte Carlo-based models that are specifically designed to reflect the key features of complex traded- and non-traded instruments, including those awarded by firms in their compensation programs and real options.

As required in FAS 123R, the Gnarus ESOVAL models used to value employee stock options are specifically designed to reflect the key features of ESOs, including risk-aversion, lack of diversification, dynamic or time-varying inputs, blackout dates, market-based payoff mechanisms, as well as employees’ exercise and termination behavior.