Stock Option Plans
Cooper Tire & Rubber Company and Xerox Corporation
Selected data from the 1998 annual report of Cooper Tire & Rubber Company follows:
Stock Options (In Part)
The Company has elected to follow APB No. 25, “Accounting for Stock Issued to Employees,” in accounting for employee stock options. Under APB No. 25, no compensation expense is recognized because the exercise price of the Company’s employee stock options equals the market price of the underlying stock at the date of grant.
SFAS No. 123, “Accounting for Stock Based Compensation,” is effective for awards granted by the Company during fiscal years beginning after December 15, 1994. The Standard requires, if APB No. 25 is followed, disclosure of pro forma information regarding net income and earnings per share determined as if the Company accounted for its employee stock options under the fair value method. The fair value for these options was estimated at the date of grant using a Black Scholes option pricing model with the following weighted average assumptions:
|
Risk free interest rate |
1998 |
1997 |
1996 |
|
Dividend yield |
5.50% |
6.10% |
6.60% |
|
Expected volatility of the Company’s |
1.30% |
1.00% |
1.00% |
|
common stock |
0.251 |
0.197 |
0.206 |
|
Expected life |
5.0 years |
6.2 years |
5.4 years |
The weighted average fair value of options granted in 1998, 1997 and 1996 was $5.84, $7.52, and $5.58, respectively. For purposes of pro forma disclosures, the estimated fair value of options is amortized to expense over the options’ vesting period. The Company’s reported and pro forma information follows:
|
1998 |
1997 |
1996 |
|
|
Net income: |
|||
|
Reported |
$126,967* |
$122,411* |
$107,884* |
|
Pro forma |
125,142* |
121,603* |
107,363* |
|
Basic and diluted earnings per share: |
|||
|
Reported |
$1.64 |
$1.55 |
$1.30 |
|
Pro forma |
1.61 |
1.54 |
1.29 |
*In thousands
Xerox Corporation
Selected data from the 1998 annual report of Xerox follows:
We do not recognize compensation expense relating to employee stock options because the exercise price of the option equals the fair value of the stock on the effective date of grant. If we had determined the compensation based on the value as determined by the modified Black Scholes option pricing model, in accordance with SFAS No. 123, the pro forma net income and earnings per share would be as follows:
|
1998 |
1997 |
1996 |
|
|
Net income as reported |
$395* |
$1,452* |
$1,206* |
|
Net income pro forma |
350* |
1,429* |
1,189* |
|
Basic earnings per share as reported |
0.53 |
2.16 |
1.78 |
|
Basic earnings per share pro forma |
0.46 |
2.12 |
1.75 |
|
Diluted earnings per share as reported |
0.52 |
2.02 |
1.66 |
|
Diluted earnings per share pro forma |
0.45 |
1.99 |
1.64 |
*In millions
The effects of applying SFAS No. 123 in this pro forma disclosure are not necessarily indicative of future amounts.
As reflected in the pro forma amounts in the table above, the fair value of each option granted in 1998, 1997 and 1996 was $13.31, $9.03 and $5.25, respectively. The fair value of each option granted was estimated on the date of grant using the following weighted average assumptions:
|
1998 |
1997 |
1996 |
|
|
Risk free interest rate |
5.2% |
6.1% |
5.7% |
|
Expected life in years |
5.3 |
5.0 |
5.5 |
|
Expected volatility |
24.9% |
23.5% |
22.0% |
|
Expected dividend yield |
1.4% |
1.9% |
2.6% |
Required a. For Cooper Tire & Rubber Company:
1. Compute the difference between reported net income and pro forma net income for 1998, 1997, and 1996.
2. Compute the difference between reported basic and diluted earnings per share and pro forma earnings per share for 1998, 1997, and 1996.
3. Comment on the apparent materiality of stock options issued to employees.
b. For Xerox Corporation:
1. Compute the difference between reported net income and pro forma net income for 1998, 1997, and 1996.
2. Compute the difference between reported diluted earnings per share and pro forma diluted earnings per share.
3. Comment on the apparent materiality of stock options issued to employees.
c. Cooper specializes in the manufacturing and marketing of rubber products for consumer use. Xerox is a leader in the global document market.
Considering the nature of these industries, which would you expect to make the more substantial use of employee options? Give your reasons.