Individual Assignment 6 - Nike (Analysis of Stock Options) (1)

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Feb 20, 2024

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Interpreting Financial Statements (ACCTG 5610) Individual Assignment 6 – Nike: Stock Options (10 Points) Individual Assignment 6 is due via Canvas before the start of class on the assigned due date. All work must be completed individually. Learning Objectives The purpose of this assignment is to ensure the student is able to: • Locate and interpret a stock compensation note. • Understand the assumptions used in the Black-Scholes-Merton option pricing model. • Consider the impact of stock compensation on motives/opportunities for financial statement manipulation. • Understand the strengths and weakness of accounting for stock based compensation. Nike Inc. (“Nike”), ticker: NKE , has stock-based compensation plans. The plans are relatively significant to the company - they recorded total stock-based compensation expense during fiscal 2023 of $755M related to their plans. The following questions pertain to Nike’s financial statements for the year ended May 31, 2023. 1. What types of stock-based compensation does the company offer? Briefly describe the different types of awards that are offered to company employees. (2 points) The NIKE, Inc. Stock Incentive Plan (the "Stock Incentive Plan") provides for the issuance of up to 798 million previously unissued shares of Class B Common Stock in connection with equity awards granted under the Stock Incentive Plan. The Stock Incentive Plan authorizes the grant of non-statutory stock options, incentive stock options, stock appreciation rights, and stock awards, including restricted stock and restricted stock units. Restricted stock units include both time-vesting restricted stock units ("RSUs") as well as performance-based restricted stock units ("PSUs"). A committee of the Board of Directors administers the Stock Incentive Plan and has the authority to determine the employees to whom awards will be made, the amount of the awards and the other terms and conditions of the awards. The Company generally grants stock options, restricted stock and restricted stock units on an annual basis. The exercise price for stock options and stock appreciation rights may not be less than the fair market value of the underlying shares on the date of grant. Substantially all awards under the Stock Incentive Plan vest ratably over 4 years of continued employment, with stock options expiring 10 years from the date of grant. 2. How does Nike estimate the risk-free rate, expected option life, and volatility for use in the Black- Scholes option pricing model? On a scale of 1 (little), 2 (some) or 3 (a lot), how much managerial judgement is employed in making estimates such as these? Why might this be a concern? (2 points) Expected volatilities are based on an analysis of the historical volatility of the Company's common stock, the implied volatility in market traded options on the Company's common stock with a term greater than one year, as well as other factors. The weighted average expected life of options is based on an analysis of historical and expected future exercise patterns. The interest rate is based on the U.S. Treasury (constant maturity) risk-free rate in effect at the date of grant for periods corresponding with the expected term of the options.

The idea that Nike analyzes ‘implied’ volatility, and ‘other factors’, suggests that there is 3 (a lot) of managerial judgement used in making estimates. This may be a concern because if there is a lot of managerial judgement being utilized, then the estimates are easily malleable. There may be concern for some malicious intent from management to sway the numbers one way or the other for Nike’s, and ultimately their own, personal benefit. 3. Using the option pricing worksheet posted on Canvas and Nike’s assumptions, estimate the Black- Scholes weighted average fair value per share of the options granted in fiscal 2023. What is Nike’s estimate? How does your estimate compare? (Please include a screenshot of your spreadsheet) (2 points) Nike’s estimate is $31.31. I got 31.55. Our estimates are close, but just over 20 cents off. It isn’t a huge difference, but when you consider how many options there are, there could end up being a huge difference in the aggregate.

4. Assume that the options that Nike granted in fiscal 2023 are exercised at some future date when Nike’s stock is worth $250 per share ( a new TikTok trend causes the share price to sky rocket! ). Under grant-date accounting , what is the cumulative amount of expense that Nike would charge against income for these options ( hint: use the estimated weighted-average fair value per share for 2023 from the 10-K --- note: this is the number that you compared your calculation against in the previous question )? Under exercise-date accounting, what is the cumulative amount of expense that Nike would charge against income for these options? Which of these (grant date or exercise date accounting) is required by US GAAP? Which provides a more representationally faithful estimate of the amount of wealth transferred from existing shareholders to employees? Ignore related tax benefits. (4 points) Grant date --- $31.31 * 12 million = $375,720,000 so 375 million Exercise-date --- 250 – 57.11 = $192.89. $192.89 * 12 million = $2,314,680,000 2.3 billion Grant date is required by US GAAP. Exercise date may provide a more representationally faithful estimate of wealth transferred to employees. There is a massive difference between the two.

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