LETTERS

OPTIONS VALUATION MODELS
I read with interest “How to Excel at Options Valuation” (JofA, Dec. 05, page 57). It appears that the strength of the binomial model presented is inversely related to the number of assumptions made. In the example given in the article, for four years of stock options granted, there are 16 assumptions—perhaps not very persuasive. For n years, there would be an exponential number of assumptions, or 2^n.

In general, one can create various simulations of stock option valuations, all based on statistically valid models. For example, a simulation based on a model whereby mean and standard deviation represent the basis for underlying assumptions can provide similar results to the binomial results but on a normal distribution scale. The latter has the added benefit of allowing the model to report a level of confidence for the simulated results.

The crux of the matter is in research that can show such a simulation is not only statistically valid but also realistic. For example, showing the value of stock options before and after an IPO vs. the simulated costing of such options may prove or disprove the validity of the valuation. A successful model that has bearing on reality can be put in the same class as the Black-Scholes method and be an acceptable alternative.

Yigal Rechtman, CPA, CFE
Person & Co. LLP
New York City

MODIFIED STATEMENTS FOR NPEs
I fully agree with the sentiments expressed in the letter “Different Standards for Nonpublic Companies?” (JofA, Jan.06, page 11). I have been financing nonpublic businesses for banks and finance companies and rely on financial statements to make credit decisions.

In particular I agree that the idea of different standards for different sizes or types of companies is extremely dangerous. Where will it end? What all users want is an accurate financial statement, and the same principles apply to all of them.

If the cost of compliance with a particular disclosure rule is out of proportion to the benefit, then the accountant preparing a statement for a credit grantor should leave it out and qualify his opinion accordingly, preferably with the prior approval of the user. My experience is that very few nonpublic companies have the items, such as stock options or pension funds, that give rise to additional disclosures and costs. It would be up to the credit grantor to accept or not accept a modified statement. I believe this approach would be preferable to tinkering with GAAP.

Neville Grusd, CPA
Executive Vice President
Merchant Financial Corporation
New York City

ANOTHER SOCIAL SECURITY FIX
In addition to the proposals offered in the letter “A Social Security Solution” (JofA, Jan.06, page 12) and the article “Promises to Keep” (JofA, Jul 05, page 41), I have one that brings the income tax system and Social Security together in a unique way.

One of the arguments offered for the creation of private accounts is that when a retiree dies the money can be passed on to his or her heirs. But most recipients of Social Security depend on their payments almost exclusively for their income. One of the last things on their minds is to pass money on to heirs. They need every dollar to pay basic needs such as housing and medicines. If private accounts were in place, guaranteed regular payments would have to be reduced.

The exception to this majority would be high-income individuals whose Social Security payments are “extra income.” The payments would simply be added to their savings.

A possible solution would be to offer high income individuals, at some time during their working career, the choice to receive a tax deduction for the amount of their yearly payments into Social Security. The deduction could be in the form of a schedule A deduction from their personal income tax return or an adjustment to total gross income before computing adjusted gross income. In exchange they would forfeit the right to receive Social Security payments when they become eligible. The total amount paid into the Social Security reserve fund would not change—the employer would match the employee deduction as usual. The employee would benefit annually with tax savings as well as with the compound interest savings and investment effect of the savings.

The IRS would have to compute the loss in income tax revenues from such a proposal and compare it to the savings in the Social Security reserve fund as a result of not having to pay future benefits. I believe there could be a net savings to the overall federal budget.

The implementation of such a system could be complex, but it would not require as radical a change in the Social Security payment system as some other proposals would.

Jimmie Wayne Knowles, CPA
Spicewood, Texas