Articles

Why Options Expensing Rule Would Be a Costly Mistake

Monday, November 10, 2003
by Marc J. Lane

Reprint permission from the November 10, 2003 issue of Crain's Chicago Business.

 

William H. Donaldson, who chairs the Securities and Exchange Commission, and his boss, President George W. Bush, are at odds over whether companies should count stock options as business expenses. The dispute may seem arcane, but its implications for business and the economy are staggering.

Mr. Donaldson promotes the expensing of options. And the Financial Accounting Standards Board has vowed to require companies to expense options beginning in 2005. Both are riding the wave of corporate reform, but the president clearly has the better argument.

Stock options are offered to lure managers and other employees to most start-up, technology and entrepreneurial concerns and to tie their compensation to the success of the company. Employees are given the right to buy company stock at a stated price at some future date, and they profit only if the company's stock exceeds that price.

At issue is whether companies will continue to have the choice to charge stock option expenses against the income they report or to disclose the options they have granted in a footnote to their financial statements.

Whether options are expensed won't make much difference. The high-tech industry's fabled supply of employee stock options is running out. Nearly three-fourths of public tech companies recently surveyed by accounting giant Deloitte & Touche LLP expect to exhaust their stock option inventory within two years. And new Securities and Exchange Commission (SEC) rules require New York Stock Exchange- and Nasdaq-listed companies to get shareholder approval for new equity compensation plans or share increases in existing plans, making it tougher for companies to replenish their supply of shares.

Add to that the legion of employees who are seething about their worthless options and wide-spread investor displeasure with excessive executive pay, and stock options may look like an outdated gimmick.

But employee stock options have been born again. The Nasdaq, where most tech stocks are traded, skyrocketed 38% in the six months after the U.S.-led coalition's forces took Baghdad. And, for the first time in years, high-tech workers have been able to cash in on their options.

But stock option plans aren't the executive-suite gimme their detractors would suggest.

According to the National Center for Employee Ownership, by 2001, between 8 million and 10 million employees had unexercised stock options in plans that granted options to at least half a company's employees. And companies with such plans experienced 28% more employee productivity than the average public company, 31% more than their paired peers.

But mandatory expensing of options would kill most broad-based plans. The companies that sponsor them would simply be unable to withstand the hit to earnings — and to stock prices. And neither is warranted because stock options might never be exercised and can't be accurately valued.

However options are reported, analysts will hyperscrutinize financial statements and zero in on the dilutive effect of exercised options, and whether options helped or harmed investors. So, stock option expensing has nothing to do with transparency. In fact, another line item on a P&L would mean less to most investors than a plain-English footnoted disclosure of the company's compensation plan.

But the price of expensing would be high. The knowledge-based economy would lose the new talent it needs to reboot, job creation would falter and U.S. companies would forfeit their competitive edge around the world. 

 

Marc J. Lane ([email protected]) is a Chicago lawyer and financial planner and an adjunct professor of law at Northwestern University School of Law.

 


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Copyright © 2003 by Crain Communications Inc.

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