A common question companies ask is whether they should reverse stock compensation expense on vested stock options that expire unexercised after the employee terminates service. The expense is actually related to the value of the stock option itself in exchange for the employee’s services, not for the actual delivery of common stock. Therefore, if the employee has earned/vested the stock option, the employee has received the promised value by being able to exercise and the company should recognize stock compensation expense for the services received from the employee.
Previously recognized compensation cost shall not be reversed if an employee share option (or share unit) for which the requisite service has been rendered expires unexercised (or unconverted).
- ASC 718-10-35-3
What is the value of a stock option?
Most option holders determine the value of the stock option by considering the intrinsic value, which is the company’s stock price less the exercise price. Let's imagine two scenarios to demonstrate that there is significant value in holding a stock option.
Scenario 1
Imagine an employee was granted a stock option allowing them to buy 1,000 shares of stock at $10.00 per share and a one year vesting term. One year later the company stock is trading at $15.00 giving the stock option an intrinsic value of $5.00 per share. At this point, this stock option is extremely valuable granting the employee access to $5,000 of profit (1,000 shares * $5.00).
Unlike actual stock, stock options itself are usually not transferable and cannot be sold. However, if they were actually able to sell the stock option, that ability to exercise is worth something. What price would the employee accept?
Scenario 2
An employee was granted the same stock option to buy 1,000 shares of stock at $10.00 per share and vests after one year. One year later the company stock is trading at $10.01 per share giving the stock option an intrinsic value of $0.01 per share and total profit of 1,000 times $0.01, or $10.
Let’s imagine that the employee is able to sell the stock option to another person, would the employee sell the stock option for $10? It may be unlikely as the same stock option in scenario 1 was able to produce a profit of $5,000 if the company’s stock price goes up to $15. If the employee won’t sell it for $10, what price would the employee sell the stock option for?
Conclusion
The actual price may be highly subjective but the point is that upon vesting and gaining the ability to exercise, the employee has gained some amount value regardless if they choose to exercise or not. Therefore, the company should not reverse compensation expense on vested stock options.