No. of Recommendations: 5
More Logic on Options

Wednesday, April 7, 2004

LAWMAKERS CONSIDERING whether companies should be required to report the value of employee stock options as expenses on their corporate balance sheets might want to take a look at a new report on the topic from their own budget office. The Financial Accounting Standards Board, the private body that writes rules for the accounting industry, has just proposed a rule -- more than a decade in the making -- that would require companies to show the fair market value of options as expenses. Anti-expensing forces, led by high-tech firms that rely heavily on options to attract employees, are pressing a measure in Congress that would block the FASB rule from taking effect. The Congressional Budget Office analysis of the issue is therefore timely -- and just as important, it's written in language understandable to those without advanced accounting degrees....

...Those fighting the new rule dismiss the CBO report, saying the nonpartisan budget office isn't known for its accounting expertise. But the accounting experts -- at the FASB and at its international counterpart, as well as the leading accounting firms -- support expensing. Opponents of expensing also claim that Congress must act because the green-eyeshade types aren't taking into account the devastating effect they say expensing will have on the economy; the legislation they are pushing would block the FASB rule while an economic impact study is conducted. Yet the CBO says requiring expensing "is unlikely to hurt the overall economy" and in fact could make it more productive. The anti-expensing forces are running out of arguments.


http://www.washingtonpost.com/wp-dyn/articles/A56322-2004Apr6.html?referrer=email
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Hi All -

Do you options have an impact on our investments? Yes, definitely. Is expensing the appropriate way to account for it? No, it isn't.

The impact of stock option grants is on share dilution. In addition, share buy-backs effectively transfer wealth from the owners of the company to shareholders.

How would I deal with this thorny issue?

Well, I would require that earnings always be reported first and foremost as fully diluted earings, so that we see the impact in the number that goes out to people in press releases, etc.

Second, I would require that cash flow spent on share buy-backs to over come dilution be broken out as a separate line item.

These two steps would appropriately highlight the impact of option grants on company ownership and shareholders equity (cash flow spent on buy-backs).

With this information in hand, shareholders will be able to make reasoned decisions on investing.

Expensing on the other hand is a game of guessing that breaks one of the cardinal rules of accounting: the "expense" isn't tied to the time frame in which it occurs.

Yours,

Jordan
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The impact of stock option grants is on share dilution. In addition, share buy-backs effectively transfer wealth from the owners of the company to shareholders.

Are you sure you don't want to rephrase that since the shareholders are the owners.

Expensing on the other hand is a game of guessing that breaks one of the cardinal rules of accounting: the "expense" isn't tied to the time frame in which it occurs.

That's the best argument I've yet read in opposition to expensing options. I think it's incomplete, but it's good!

KennyO
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Hi Kenny -

Thanks for catching my typo!

The sentence:

The impact of stock option grants is on share dilution. In addition, share buy-backs effectively transfer wealth from the owners of the company to shareholders.

should read:

The impact of stock option grants is on share dilution. In addition, share buy-backs effectively transfer wealth from the owners of the company (the shareholders) to employees.

To develop this theme further: if a company spend $100M on share buy-back to counter dilution or potential dilution due to option grants, that $100M (even if employees don't exercise the options), is in essence transferred to the employees

Yours,

Jordan
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The word "employees" needs to be preceded and modified by the phrase options granted. Too frequently this group includes very few employees. Besides, probably most executive management individuals don't think of themselves as "employees" very often.

If options were indeed granted to all employees (in equal volume) it might not be so bad.

Sharon

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Hi Sharon -

Some recent research on employee option grant distribution shows some surprising facts.

1. It just isn't in High Tech that options are broadly distributed.

2. Option grants are more broadly distributed than people believe in terms of within a companies and across indeustry.

That said, there are enough situations where options have been concentrated in the hands of a few senior executives, and what has happened is that wealth has been transferred to those executives - without proper disclosure - at the expense of the shareholders.

Yours,

Jrdan
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