Forfeiture Rate Calculation
I am trying to calculate the forfeiture rate for the last grant. I
have ten years of actual forfeiture data. What I noticed right away was
that for every grant there was some forfeiture but the actual forfeiture
goes from 3 to 28%. My group size is only twenty five people and
the variance in the number shares granted to the group members is very
high. In order for the grants to vest the employee has to still be an employee
at the end of the three year vesting period. We have already exceeded
the estimated forfeiture for the two non vested grants. The actuals for those
two grants are in the range of 10%.
How do others calculate the estimated forfeiture rate when it really seems
like a really random estimate, at least to me. I am guessing that I may
need to do some type of modeling.
Thanks,
Mike
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If you are a FAS 123R or Valuation pro, your assistance would be apprreciated on this.
Dan
Hi Michael,
To start with, you are correct in that historical forfeiture rates have volatile swings and range greatly. That may be true because forfeiture rates are highly correlated with stock price appreciation (well in-the-money awards are very retentive, and out of-the-money awards are less retentive). Most companies start with their historical data however and work from there by developing an "annual" rate of forfeiture. From your email, I was unsure if you were developing an annual rate of forfeiture or an aggregate rate of forfeiture, however I would recommend that you get to an annual rate of forfeiture.
Further, a forfeiture rate is effectively a termination rate for your employees. Some companies who have pension plans or Executive SERP plans use the actuarial termination rates from their pension plan or their SERP plan based upon the ages of their option holders. Therefore, theoretically you can look at the age of each of the 25 employees, and then use an age-based termination table, to develop an expected termination rate (forfeiture rate) for each employee - and come up with a single weighted average of these rates. The benefit of this is that it is a forward looking estimate of forfeiture, that is consistent with other FAS87/FAS112 financial reporting.
I hope this is helpful. Don't hesitate in reaching out to me at 215.255.1802 if I can be more helpful by the phone.
Terry