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Federal Register / Vol. 86, No. 228 / Wednesday, December 1, 2021 / Rules and Regulations
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Question 1: When determining the fair value of the share options in accordance with FASB ASC Topic 718, should Company D consider an additional discount for nonhedgability and nontransferability?
Interpretive Response: No. FASB ASC
paragraph 718105529 indicates that nonhedgability and nontransferability have the effect of increasing the likelihood that an employee share option will be exercised before the end of its contractual term. Nonhedgability and nontransferability therefore factor into the expected term assumption in this case reducing the term assumption from ten years to six years, and the expected term reasonably adjusts for the effect of these factors. Accordingly, the staff believes that no additional reduction in the term assumption or other discount to the estimated fair value is appropriate for these particular factors.61
Question 2: Should forfeitures or terms that stem from forfeitability be factored into the determination of expected term?
Interpretive Response: No. FASB ASC
Topic 718 indicates that the expected term that is utilized as an assumption in a closed-form option-pricing model or a resulting output of a lattice option pricing model when determining the fair value of the share options should not incorporate restrictions or other terms that stem from the pre-vesting forfeitability of the instruments. Under FASB ASC Topic 718, these pre-vesting restrictions or other terms are taken into account by ultimately recognizing compensation cost only for awards for which grantees deliver the good or render the service.62
Question 3: Can a companys estimate of expected term ever be shorter than the vesting period?
Interpretive Response: No. The vesting period forms the lower bound of the estimate of expected term.63
Question 4: FASB ASC paragraph 718105534 indicates that an entity shall aggregate individual awards into 61 The staff notes the existence of academic literature that supports the assertion that the BlackScholes-Merton closed-form model, with expected term as an input, can produce reasonable estimates of fair value. Such literature includes J. Carpenter, The exercise and valuation of executive stock options, Journal of Financial Economics, May 1998, pp.127158; C. Marquardt, The Cost of Employee Stock Option Grants: An Empirical Analysis, Journal of Accounting Research, September 2002, pp. 11911217; and J. Bettis, J.
Bizjak and M. Lemmon, Exercise behavior, valuation, and the incentive effect of employee stock options, Journal of Financial Economics, May 2005, pp. 445470, as well as more recent studies,.
62 FASB ASC paragraph 718103011.
63 FASB ASC paragraph 718105531.

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relatively homogenous groups with respect to exercise and post-vesting employment termination behaviors for the purpose of determining expected term, regardless of the valuation technique or model used to estimate the fair value. How many groupings are typically considered sufficient?
Interpretive Response: As it relates to employee groupings, the staff believes that an entity may generally make a reasonable fair value estimate with as few as one or two groupings.64
Question 5: What approaches could a company use to estimate the expected term of its employee share options?
Interpretive Response: A company should use an approach that is reasonable and supportable under FASB
ASC Topic 718s fair value measurement objective, which establishes that assumptions and measurement techniques should be consistent with those that marketplace participants would be likely to use in determining an exchange price for the share options.65 If, in developing its estimate of expected term, a company determines that its historical share option exercise experience is the best estimate of future exercise patterns, the staff will not object to the use of the historical share option exercise experience to estimate expected term.66
A company may also conclude that its historical share option exercise experience does not provide a reasonable basis upon which to estimate expected term. This may be the case for a variety of reasons, including, but not limited to, the life of the company and its relative stage of development, past or expected structural changes in the business, differences in terms of past equity-based share option grants,67 or a 64 The staff believes the focus should be on groups of employees with significantly different expected exercise behavior. Academic research suggests two such groups might be executives and non-executives. A study by S. Huddart found executives and other senior managers to be significantly more patient in their exercise behavior than more junior employees. Employee rank was proxied for by the number of options issued to that employee. See S. Huddart, Patterns of stock option exercise in the United States, in: J.
Carpenter and D. Yermack, eds., Executive Compensation and Shareholder Value: Theory and Evidence Kluwer, Boston, MA, 1999, pp. 115142.
See also S. Huddart and M. Lang, Employee stock option exercises: An empirical analysis, Journal of Accounting and Economics, 1996, pp. 543.
65 FASB ASC paragraph 718105513.
66 Historical share option exercise experience encompasses data related to share option exercise, post-vesting termination, and share option contractual term expiration.
67 For example, if a company had historically granted share options that were always in-themoney, and will grant at-the-money options prospectively, the exercise behavior related to the in-the-money options may not be sufficient as the
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lack of variety of price paths that the company may have experienced.68
FASB ASC Topic 718 describes other alternative sources of information that might be used in those cases when a company determines that its historical share option exercise experience does not provide a reasonable basis upon which to estimate expected term. For example, a lattice model which by definition incorporates multiple price paths can be used to estimate expected term as an input into a Black-ScholesMerton closed-form model.69 In addition, FASB ASC paragraph 71810
5532 states that . . . expected term might be estimated in some other manner, taking into account whatever relevant and supportable information is available, including industry averages and other pertinent evidence such as published academic research. For example, data about exercise patterns of employees in similar industries and/or situations as the companys might be used.
Facts: Company E grants equity share options to its employees that have the following basic characteristics: 70
The share options are granted atthe-money;
Exercisability is conditional only on performing service through the vesting date; 71
If an employee terminates service prior to vesting, the employee would forfeit the share options;
If an employee terminates service after vesting, the employee would have a limited time to exercise the share options typically 3090 days; and The share options are nontransferable and nonhedgeable.
Company E utilizes the BlackScholes-Merton closed-form model for valuing its employee share options.
Question 6: As share options with these plain vanilla characteristics have been granted in significant quantities by many companies in the past, is the staff aware of any simple methodologies that can be used to estimate expected term?
Interpretive Response: The staff understands that an entity that is unable to rely on its historical exercise data sole basis to form the estimate of expected term for the at-the-money grants.
68 For example, if a company had a history of previous equity-based share option grants and exercises only in periods in which the companys share price was rising, the exercise behavior related to those options may not be sufficient as the sole basis to form the estimate of expected term for current option grants.
69 FASB ASC paragraph 718105530.
70 Employee share options with these features are sometimes referred to as plain vanilla options.
71 In this fact pattern the requisite service period equals the vesting period.

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