May 4, 2005 5:48 PM PDT

Companies sidestep some stock option expenses

Sun Microsystems, Advanced Micro Devices and several other computing companies have begun using an accounting technique to avoid recording millions of dollars in stock option grants which, based on upcoming regulations, would otherwise be reported as expenses.

The companies are essentially sidestepping the new expense requirement by accelerating the schedules by which some stock options "vest," or become eligible for employees to buy. In Sun's case, the company disclosed Wednesday in a regulatory filing that it expects to avoid having to take a $400 million pretax charge for the options.

Among other companies that disclosed similar moves in recent weeks, International Rectifier said it expects to avoid a $106 million charge; Micron Technology, $100 million; Linear Technology, $75 million; Fairchild Semiconductor, $27 million; Agile Software, $20 million; RF Micro Devices, $16.7 million; and PEC Solutions, $9.5 million. AMD and Boston Communications Group, another high-tech firm employing the accounting practice, didn't disclose the charges they expect to avoid recording.

Computer technology companies have long favored using stock options as a form of compensation, and have vigorously opposed impending regulations that will elevate them from a footnote in financial statements to an expense that directly hurts the bottom line on an income statement.

Most companies are accelerating vesting only for "underwater" stock options whose purchase price is above current market prices. That accounting action may be taken without requiring a financial charge. International Rectifier, however, is accelerating vesting for all options and is taking a $4 million charge.

"The purpose of the acceleration is to enable the company to avoid recognizing compensation expense associated with these options in future periods in its consolidated statements of operations" when the new accounting rules go into effect, Sun said in its regulatory filing. "The company also believes that because the options to be accelerated have exercise prices in excess of the current market value of the company's common stock, the options have limited economic value and are not fully achieving their original objective of incentive compensation and employee retention."

The Financial Accounting Standards Board decided in December to require that stock options be recorded as an expense in corporate accounts beginning in June. That's a significant change from current practices that require companies merely to disclose how many options they've granted.

Scott Webster, a partner at Goodwin Procter, supports stock option expense rules, but the recent spate of accelerated vesting shows that the "tail is wagging the dog" when it comes to the current business and regulatory climate. "People are making their business determinations based on what the accounting rules are and not on what's good for the business," Webster said.

Ultimately, a better approach is to issue restricted stock rather than stock options, the approach Microsoft took, said Charles Elson, director of the Weinberg Center for Corporate Governance at the University of Delaware. Otherwise, he said, companies shouldn't accelerate vesting because "interfering with the vesting schedule interferes with the incentive."

Companies have a legitimate point when complaining about the method for assessing the worth of stock options, Elson added. "There is not really a good metric for valuing these things," he said.

Stock options give employees the right to purchase, at a certain price, a company's stock in the future. Often, the stock options in a particular grant "vest" over a period of years, meaning that new batches of stock gradually become available for purchase. Stock options were offered to employees to encourage them to stay with the company and help it succeed, since the value of the options would grow if the company's stock price increased over the purchase price of the options.

Some companies, including Amazon and Computer Associates, began recording stock options as expenses early on. And in April, IBM made the change, a shift that pruned away 11 percent of the company's net income in 2004, reducing earnings per share from $4.94 to $4.39.

Even though the regulatory change is merely a different way to report the same information, it likely will have long-term effects on stock-option grants, Webster said. "I do think companies are going to be granting a lot less options going forward."

CNET News.com's Ina Fried contributed to this report.

 

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