March 3, 2004 4:55 PM PST

Businesses rally against stock option plan

Businesses opposed to mandatory stock option expensing descended on Capitol Hill on Wednesday to warn that such a requirement might cost jobs and unfairly harm start-up companies.

Art Coviello, RSA Security's chief executive, told a House Financial Services subcommittee that "the mandatory expensing of all employee stock options is without any clear or generally accepted accounting rationale. (It) will destroy broad-based plans as we know them and the productivity, innovation and economic growth they generate."

More than 80 percent of RSA's employees received stock options in the last four years, and three-quarters of those options were granted to employees who were not corporate officers or directors, Coviello said.

Coviello and the other industry representatives who testified urged Congress to block a proposal expected from the Financial Accounting Standards Board (FASB) later this month. They said the FASB, a 21-year-old private body that sets expensing rules, is likely to require companies to expense employee stock options, using a controversial formula.

While this may seem like an arcane dispute only an accountant or tax lawyer could appreciate, stock options have become part of the Silicon Valley culture over the last 20 years. Companies view them as a way to retain loyal employees who will work harder as co-owners of the firm. And they dangle the enticing prospect of wealth: One book published last year estimated that nonexecutive workers at the top 100 Internet companies made an average of $425,000 in stock option profits between 1994 and July 2002.

When employees cash in stock options, they dilute the value of existing shares, making each one worth a tiny bit less. The FASB is expected to require companies to treat exercises of stock options as expenses, which would mean that they would report reduced profits to shareholders. Such an expensing requirement would mean that start-up companies would be less likely to grant options to new employees in the first place.

That's not a terrible outcome, according to some FASB backers, like Harvard University economics professor Robert Merton, a Nobel laureate who testified Wednesday. "I find it rather difficult to accept the prospect that the financial accounting treatment of expensing options will have a profound effect on this nation's economic prosperity," Merton said. To do otherwise, he said, would be to continue "a deliberate accounting distortion."

Business representatives are lending their support to a bill called the Stock Option Accounting Reform Act, which would essentially prevent federal securities regulators from recognizing any FASB decision. It would, however, require the expensing of stock options granted to a company's CEO and four other top executives, if the company had annual revenue of at least $25 million. Backing the measure are legislators representing Silicon Valley.

Mark Heesen, president of the National Venture Capital Association, said "our country's small, start-up companies are being threatened by the Financial Accounting Standards Board's quest to unilaterally mandate the expensing of employee stock options.

"International convergence of accounting standards such as mandatory expensing will touch the U.S. and Europe, not China and India, where, we fear, accounting standards more supportive of stock options will drive more highly skilled jobs offshore."

The prospects for the bill's enactment, however, seem uncertain. Key senators have expressed their reluctance to interfere with FASB's decisions.

Microsoft announced last July that it would no longer give new employees stock option grants. Rather, it would give them outright grants of stock that would vest over a period of years in much the same way that stock options do.

 

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