Perspective: The chilling effects of stock option expensing

Charles Cooper's recent commentary on stock options has generated a fair amount of reader comments.

But the column failed to note that if the drive to expense employee stock options succeeds, financial statements will become worse, not better.

It will mean the end of many broad-based options programs, curtailing the American innovation and creativity that sets us apart globally, and that fundamentally, America's workers, businesses and overall economy will pay the cost.

Mandatory expensing is a bad idea for many reasons, and here are the top 10 (in reverse order) to consider:

10. FASB can't consider the economy
The Financial Accounting Standards Board wants to mandate the expensing of options but admits that as a board of accountants, it can't--and won't--assess the economic impact of its decision.

The U.S. Senate needs to act to keep this dream alive.

Silicon Valley Rep. Anna Eshoo warns that "without immediate action by Congress, FASB's ill-advised mandatory expensing rule will go into effect without any examination of its impact on American workers, their employers or the U.S. economy, leaving the future of this important employee benefit in doubt."

9. A chilling effect
A February survey by Deloitte Touche Tohmatsu found that 75 percent of companies surveyed intended to reduce the use of employee stock options. The primary reason for this shift? The cost impact of expensing the options.

8. Don't stifle productivity
Rutgers University professors Joseph Blasi and Douglas Kruse found that "employee ownership improves a company's productivity level by about 4 percentage points and that total shareholder returns increase by some two percentage points, relative to other firms. Profit levels--as measured by return on assets, return on equity and profit margins--jump by about 14 percent."

7. It's not just high tech
Companies across the country and from many industries believe that the FASB is wrong--including J.C. Penney, Gap, Human Genome Sciences, Pfizer, McDonald's, Starbucks, Staples and the Vermont Teddy Bear Co.

6. There's another way
The House of Representatives voted 312-111 for the Stock Option Accounting Reform Act. This bill requires the immediate expensing of a company's top five executives' stock options.

Ninety percent of the 14 million Americans who receive options are nonmanagers.

Small businesses are exempted from this obligation and cannot be required to expense options for the three years after an initial public offering. The bill requires a federal economic impact study of the effect of expensing options, before any further expensing measures are taken, along with new disclosure rules for companies that offer options. Similar legislation is now before the Senate.

5. Employees have spoken
Hundreds of companies and thousands of employees representing millions of working Americans have expressed their concerns. FASB received more than 6,000 comment letters, many from rank-and-file workers. More than 90 percent of the letters opposed the option-expensing scheme.

4. Barons of Silicon Valley? Ha!
Charlie Cooper's column called the people who receive employee stock options "barons." Nothing is further from the truth. Ninety percent of the 14 million Americans who receive options are nonmanagers.

3. It's bad accounting
FASB can't devise a model for accurately valuing employee stock options. Cisco Systems tried to use the proposed model and came up with numbers that varied 365 percent. William Sahlman, a Harvard Business School professor, says, "If anything, expensing options may lead to an even more distorted picture of a company's economic condition and cash flows than financial statements currently paint."

2. No iPod?
Without employee stock options, will we get the next Google, eBay or Apple Computer? Will employees be willing to work and think like owners if they don't have a chance to become owners? Andy Bechtolsheim, co-founder of Sun Microsystems, has said that without options, three out of four Silicon Valley start-ups would have likely failed. Without stock options, many would-be market drivers will never reach their potential, lacking both the incentives and pride of ownership needed to make the leap from upstart to powerhouse.

1. The American Dream
Says Cisco employee Ken Platt in a letter to the FASB: "I have worked as a small child, harvesting and packing produce in Arizona, as a young teenager working to help grow the family business, as a U.S. Navy diver and 20-year veteran, struggling to provide for my family, attending school at night and spending many months away pulling duty overseas, protecting our country...As a productive member of Cisco, I am just now beginning to see the fruits of my labors, the beginnings of success and to realize the American Dream. Now you want to take this away from me?"

The U.S. Senate needs to act to keep this dream alive.

Biography
Rick White is chief executive of TechNet as well as chairman of the International Employee Stock Options Coalition.

More Perspectives

[swwg69]

Stock Options

FASB is not wanting to outlaw stock options.
They just want to aviod having companies with
HUGE debt potential that is unreported.
CLUE: 3 out of 4 dot coms went bust even with
stock options.
They should be able to account for these as
the debt potential accrues.
What would be the cost of these options be if
they were exercised today, and put some of that
money away in case they are exercised.
FASB is trying to look out for the 90% that have
stock options and may never get to use them.
The Barons will always find a way to get the cash.

FASB's all wrong on Stock Options?

Rick White's article describes a "self-serving" position on not expensing stock options. Perhaps he should read Warren Buffett's "Fuzzy Math & Stock Options" for a more informed opinion:

<a class="jive-link-external" href="http://www.washingtonpost.com/wp-dyn/articles/A29807-2004Jul5.html" target="_newWindow">http://www.washingtonpost.com/wp-dyn/articles/A29807-2004Jul5.html</a>

Why continue playing the silly numbers games?

contorted logic?

Critics of the stock option reporting requirement often use selective "statistics" to support their arguement. First of all, I can't tell you how many times I've heard the claim that no one can figure out how to price options. Trillions of dollars per day in derivatives are traded throughout the world. I would hardly expect that the financial industry could continue without A) a valid pricing model and B) market-based assessment of such factors as volatility. If a CFO has no idea how to value a call he/she should just go to the market for a quote. If no trading exists there are plenty of independent sources to help calculate proper, documentable values.

Further, one obvious half-truth in your justifications is that 90% of options are owned by 14 million workers. To be a little more honest you might show the weighted average of ownership that would surely show a distribution and concentration of wealth similar to executive compensation vs. average worker salary. Enlisting the rank &#38; file as support for your position is disingenuous.

To say that expense recognition curtails innovation, "creativity", etc. is also hypocritical. The fact is that much of the tech sector (and other industry) innovation was/is purchased by underpaying talent. Expensing options actually helps the recipients gauge their compensation more exactly. As an employee I can, for instance, decide whether I'd prefer $1000 in salary vs. 25 lottery tickets if I actually know the expected value of those lottery tickets. Too often corporations have used the lure of the big score via options as a way to simply spin off risk on employees.

Let's face it, corporate exces don't like the FASB ruling because it removes a loophole in their ability fleece unsuspecting employees and investors.

White made some fundamental errors.

Though the FASB's proposal is commonly expressed as expensing stock options, stock options cost the awarding company nothing. The existing stockholders bear the cost, in dilution of their portion of the total stockholdership. The expensing is of the value of the services the awarding company receives from the employees when they are awarded the options. The services are valuable, and using them up is an expense that should be reported in the awarding companies' income statements. Such expense is best measured by the value of the options at the date of grant.

Virtually all of the concern White expresses is for the effects on the awarding companies and their employees of the proposal. That ignores the purpose of financial reporting, which is to help the users of the financial reports make better investment and disinvestment decisions. The primary concern should be for the welfare of the users, and thereby of the economy at large (though White contends the "overall economy will pay the cost."

White says that if the proposed change is enacted, "financial statements will become worse, not better," supporting that position solely with reason number 3:

"FASB can't devise a model for accurately valuing employee stock options. Cisco Systems tried to use the proposed model and came up with numbers that varied 365 percent. William Sahlman, a Harvard Business School professor, says, 'If anything, expensing options may lead to an even more distorted picture of a company's economic condition and cash flows than financial statements currently paint'"

If Cisco Systems wanted to charge the value of the services of its employees compensated by stock options, it would find a way to do it, for example, by conferring with the FASB.

Sahlman is entitled to his opinion, as are the multitude of professors who disagree with him. If White weren't the CEO of TechNet and had the welfare of the users of financial statements as his primary concern, he would quote one of those other professors instead.

White says in reason (1) that FASB can't--and won't assess the economic impact of its decision. On the contrary, it makes such assessments for every proposal. It decides whether the proposal will help the users make better decisions, and thereby help the economy. What it can't and won't do is tilt toward a special interest such as high tech industry companies at the expense of the welfare of the users of financial reports and thereby of the economy.

In reason (9), White refers to "he cost impact of expensing the options." He doesn't specify what cost he has in mind. The only thing it costs the awarding company directly is a little extra ink in the production of its financial reports. And the assertions that making the proposal final would have these results:(1) reduce the awarding of stock options and (2)harm the awarding companies and/or their employees, are merely that, assertions. The International Accounting Standards Board requires awarding companies around the world to report expense in this connection, and no such results have thus far been reported.

Having the U.S. Congress in effect establish financial reporting standards, to which White refers in reason (6), would eviserate the standard setting process, with special interests who can make the largest campaign contributions calling the shots with no regard for the quality of financial reporting, for the welfare of the users, or for the welfare of the economy.

Stock Options and accounting principles

I have a lot of expensive "wallpaper", in the form of stock options issued to me by a prior employer. Subsequent to their receipt, the employer entered a period of financial turbulence, the immediate result of which was the laying off of thousands of employees and the closing of regional offices. I was unable to exercise my options, as the company eventually folded, reemerging years later in a new form.
I believe the appropriate method of recognizing this form of compensation is to account for the number of options issued in annual statements, with the value. The employee does nothing in tax return preparation, as no income has been received. However, I would have no problem with a non-punitive reporting of the receipt, if the tax liability were unaffected. Now, if and when the employee or ex-employee should exercise the option, it would be reported appropriately to the IRS as additional income, and concurrently noting in the return the purchase of stock. The company would report the income of cash, and the issuance of the appropriate number of shares to the named individual.

I don't know why the process is so misunderstood by so many in positions of authority.

I believe, however, that some special reporting must be mandated in the case of options awarded to executives as additional compensation. That, in my opinion, is a completely different issue, and possibly the incentive should be called something else than options. Or, possibly we need a distinction between true performance options awarded to employees after a period of financial success, and incentive options awarded as a monetary gain to certain key employees.

Doug Thomas, Rio Rancho, NM

[MyLord]

Costs are best controlled

not ignored or pushed off on the unsuspecting public. If options cost too much, they can be priced out of the money to reduce it, and if they still cost too much perhaps there should be less. Yes, employee ownership is desirable, but there are many ways to accomplish this. Options are a rather poor choice for rewarding performance anyway since a rise in the market may have nothing to with services rendered. It is really just a matter of honesty.

Complete Malarkey!

As Alan Greenspan states "A stock option is a unilateral grant of value from existing shareholders to an employee" and "To assume that option grants are not an expense is to assume that the real resources that contributed to the creation of the value of the output were free. Surely the existing shareholders who granted options to employees do not consider the potential dilution of their share in the market capitalization of their corporation as having no cost to them"

To accurately reflect a companies true market value these options must be expensed. FASB will have done the right thing when they make the companies financial statements accurate by requiring proper accounting for stock options.

More accurate books are better for everyone

Companies are ALREADY required to list the
options they've given in their financial
statement. It's the listing of the expenses on
the income statement they are fighting as this
changes greatly what they are allowed to list as
their earnings per share. The bottom line is
that the simple reports many people read are
misleading but all banking institutions actually
read the financial statements and know all about
the options that have been given away and
account for it.

Note that many companies have been overpowered
by shareholders and forced to expense options.
Ask yourself why shareholders would want a less
accurate assessment of stock they would own.
The whole argument against expensing this stuff
is quite hollow.

Chris