Pricing Model Management: Evidence from Employee Stock Option (Un)Fair Valuation

60 Pages Posted: 2 Sep 2015 Last revised: 24 May 2016

See all articles by Loïc Belze

Loïc Belze

EMLYON Business School

Francois Larmande

HEC Paris - Accounting and Management Control Department

Lorenz Schneider

EMLYON Business School

Date Written: May 23, 2016

Abstract

This paper examines the reliability of valuation models used in fair value accounting. Departing from earlier literature focused on input estimates, we study management of the valuation model itself, detected in the ad hoc adjustments made by preparers to generally accepted models. Our analysis is based on a unique sample of listed ESOs in an IFRS context for which detailed disclosure is available. We find evidence of model management, with a material median understatement compared to a generally accepted benchmark model, which is designed to control for ESO-specific characteristics and input estimates. Furthermore, we identify three levers for model management: non-tradability of the option, transaction costs incurred to hedge the option, and to a lesser extent dilution. Based on option pricing literature, a close examination of the arguments used to justify these ad hoc adjustments suggests that they lead to unreliable estimates. By highlighting valuation model reliability as a relevant concern for fair value measurement, as distinct from the issue of input estimate reliability, this study has direct consequences for preparers, auditors, and standard setters.

Keywords: Fair value, ESO, Transaction costs, IFRS 2, Dilution, Non-Tradability

JEL Classification: M12, M41, G30, G13, J33

Suggested Citation

Belze, Loïc and Larmande, Francois and Schneider, Lorenz, Pricing Model Management: Evidence from Employee Stock Option (Un)Fair Valuation (May 23, 2016). HEC Paris Research Paper No. ACC-2015-1103. Available at SSRN: https://ssrn.com/abstract=2654183 or http://dx.doi.org/10.2139/ssrn.2654183

Loïc Belze

EMLYON Business School ( email )

23, av. Guy de Collongue BP 174
69132 Ecully Cedex
France
+33 478 337 800 (Phone)
+33 478 337 928 (Fax)

HOME PAGE: http://www.em-lyon.com/fr/faculte-recherche-enseignement-superieur/faculte-recherche-emlyon/corps-pr

Francois Larmande (Contact Author)

HEC Paris - Accounting and Management Control Department ( email )

Jouy-en-Josas
France

Lorenz Schneider

EMLYON Business School ( email )

23 Avenue Guy de Collongue
Ecully, 69132
France

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