The fair value of employee stock options

: Nestlé’s case study

Abstract

The issuance of IFRS 2 – Share-based payment, in 2004, raised several criticisms, mostly related with one specific type of share-based payment transaction – employee stock options (ESO). The mandatory recognition and disclosure of its fair value impacted not only profitability, but also a corporate governance related issue – executives’ remuneration. Given the specificities of this particular type of call options, entities are faced with some difficulties in applying option pricing models to its valuation, but are also faced with opportunities to exercise managerial discretion over the model inputs. This thesis analyses and comments IFRS 2 guidelines in detail, supported by existing literature. It also applies the guidelines provided by this standard to a specific case study – Nestlé’s employee stock options granted in 2011 - to truly understand the difficulties and opportunities that an entity faces when estimating fair value of ESO. After providing 28 valid alternative valuations for the same ESO grant, we conclude that, in 2011, Nestlé apparently understated the amount expensed with regard to the ESO granted, possibly due to opportunistic motivations to reduce the perceived executives’ remuneration and to increase the perceived entity’s profitability. To finalise, we provide recommendations on additional disclosures, which would improve the transparency and quality of the information provided by the financial statements.

Date of Award	2012
Original language	English
Awarding Institution	Universidade Católica Portuguesa
Supervisor	Paulo Azenhas (Supervisor)