FAS 123R Standard
“The Expected term of… share options or similar instruments, “including a discussion of the method used to incorporate “the contractual term” of the instruments and “employees expected post-vesting employment termination behavior also would be factored” into the fair value (or calculated value) of the instrument.
– FAS 123R paragraph A31
Montgomery Investment Technology, Inc. (MITI) applies multiple analytical approaches to calculate an accurate and justifiable expected term, consistent with FAS 123R and SEC SAB 107 guidelines. Some of the techniques used are illustrated below
SEC SAB 107
The SEC has provided a formula for calculating the Expected Term that may be used until December 31, 2007. Subsequently, the Expected Term will have to be calculated and documented based on historical and projected exercise behavior.
Weighted Average Time Outstanding
The Expected Term is estimated as the weighted-average of the outstanding period of time for each potential transaction. The Time to Transaction (i.e., exercise) is either inferred from historical data or is projected based on the expected early exercise behavior of the employees. The weighted-average is based on the number of options exercised and expired.
Black-Scholes Implied Expected Term
The fair value is computed for each potential transaction using the Black-Scholes formula. The Time to Transaction (i.e., exercise) is either inferred from historical data or is projected based on the expected early exercise behavior of the employees.
Lattice Implied Expected Term
The fair value calculated using the Lattice Method can be used to derive the Implied Expected Term. This result can be plugged into the Black-Scholes formula as the Time to Expiration input.