Should Companies Expense Stock Options? 418
A reader writes : "The New York Times is running a story about proposed accounting changes to force companies to expense stock options. Is this a necessary and proper oversight measure to enforce financial discipline on companies that might otherwise have none? Or would this measure basically stop companies from offering fiduciary responsibility incentives to their employees? What do you think about this? What should the final decision be? And what measures should be taken to influence the decision-making process?"
Accuracy (Score:3, Insightful)
But at least other things in accounting can be measured with modest accuracy.
Well duh. (Score:5, Insightful)
Cost of stock options (Score:5, Insightful)
Options have value, and people will pay for them. By giving them away the company is basically giving away money. To say there is no cost is not accurate, and the owners deserve to have the most accurate picture of comapny finances available.
No way! (Score:2, Insightful)
Don't mix things up! (Score:5, Insightful)
Individual Employee's options are a great way to retain employees, keeping them motivated and having them think big picture, but they just can't fake the bottom line.
And guess who's options would definitely go away?
Re:Well duh. (Score:1, Insightful)
Of course, my response to my company is "fuck off you fucking shitholes". My company suckered me in with a ton of stock options during the heyday and before they vested, they were worth NEGATIVE a couple million dollars. Mine will never *ever* be worth a fucking thing. Plus, my company is going on and on about possible layoffs (we've already cut 30% of the company) all the time.
So really, why should I give a fuck? My company can go fuck themselves for all I care. They gave me shit and I'm supposed to help them out for it?
Wrong (Score:3, Insightful)
If you expense stock options when granted, you have to make an estimate as to their value/cost and use that in the financial statement. The problem is that, when granted, stock options do not cost anything to the company and have no dollar value, and they may never. It is likely that in most cases, the estimated value when they are expensed will be revised when the options are exercised.
Right now, companies do one of two things when options are exercised: they either grant new shares, diluting the existing stock; or they buy back shares (or use shares already held back) equal to the amount exercised so as to not dilute the stock. Both methods have their merits, but the point is that it is only at the time of sale when the true cost of the option is known. So why change the way things are working? I suppose we could force all companies to buy back instead of dilute the share pool, but, I really don't see any case for expensing them when granted.
Options should only be expensed when they are exercised, which is exactly what happens today. Why do we need to change?
Re:Not IF but HOW, [ expense only the gains?? ] (Score:3, Insightful)
As CEO, I work hard to increase share price to benefit the shareholders. I somehow achieve my goal, then all my employees (including me) exercise/sell to reap the benefits. Suddenly my earnings take a huge hit. Boom, my stock price crashes. Sure, I could call it a one-time charge, but option exercise/sell is basically out of my control and could happen every quarter. In the end, shareholders and financial analysts would have to ignore this aspect of my earnings, which brings us back to the situation we have today.
Stock dilution (Score:3, Insightful)
The only way to stop this is to buy back stock, which is a huge expense.
Re:Value of options (Score:2, Insightful)
Re:Cost of stock options (Score:3, Insightful)
Options have value, and people will pay for them. By giving them away the company is basically giving away money. To say there is no cost is not accurate, and the owners deserve to have the most accurate picture of comapny finances available.
The question is how you record them.
No, they are not an expense when they are issued.
No, they are not an equity when they are issued.
Yes, they are an expense and an equity when they are excersized.
Given the volitility of the stock market, what IS the expense of an option?
If I were creating an accounting system for this (and I am not a cerfied public accountant, though I do my own accounting for my business), I would do as follows:
1) Create a liabilities account for the strike price of unexersized options. And an expense account for losses on exersized options.
2) When an option is issued, it becomes a liability, which is usually paid with equity.
3) When an option is exersized it is paid with equity. The equity is deducted at *full market price* and the balance is debited to the expense account for option losses.
This seems pretty accurate to me. But the balance sheet will NOT show what the actual expenses are. Basically it makes the whole financial document system that much harder to navigate.
Re:Fiduciary responsibility incentives? (Score:5, Insightful)
I've had long discussions about options with my friends. I finally realized the only sensible objection to stock options. And that is they have no impact on the cash position of the company. When a company is small or newly founded, it doesn't really make sense to value options, as at that point the cash poisition of the company is the overriding concern; this allows start-ups to offer compensation that, while not equal to that of larger companies, offers a tremendous possible upside to employes. Once cash flow is no longer really concern, it's convenient to continue to give options, as it doesn't count against the income statement. At this point, Warren Buffet's words quoted elsehwere (if options aren't compensation, what are they; don't we expense compensation?).
In short, options for start-ups make sense, and no one really cares what the GAAP earnings are-- cash flow is much more important. For established companies, cash flow is often difficult to relate to the success of a company, so using GAAP earnings makes sense, and options should be expensed. And I have no idea what "fiduciary responsibility incentives" are, and the submitter doesn't either.
Consider SCO (Score:3, Insightful)
Re:Warren Buffett's take on it (Score:4, Insightful)
A response to Buffett is here [catallarchy.net].
I have to agree. Issuing options (or additional shares) imposes a cost to existing shareholders via dilution, but the total value of the company is unchanged. The company is just transferring equity from one group of investors to another.
Re:Well duh. (Score:2, Insightful)
I'm guessing further that if the stock options are expensed, the "possible layoffs" will become "definite layoffs".
I'm guessing still further that the reason your company is spamming you to oppose option expensing isn't so much because they care about preserving your job, but because they care about preserving the company itself (and all the jobs in it).
I'm guessing still further that you took a gamble when you accepted options as compensation, probably because it seemed like a good idea (or the lesser of two evils) at the time, and that you're complaining overmuch now that your gamble hasn't paid off.
I'm guessing that you're definitely complaining overmuch, considering as how you haven't left the company in spite of how much you claim to hate them.
And it's the last one that really bugs me. I figure, you must have some compelling reason to stick with this company, even though they took all your hard work and failed to turn it into a strong, profitable business plan.
If you insist on working at this company, then shouldn't you also insist on doing whatever you can to prevent the company from laying you off and/or going out of business?
What do you gain by working there, that you would not gain more of by opposing option expensing?
Make up your fucking mind: either support the company you work for, or quit. Staying on the payroll while working through acts of commission and omission to undermine and weaken the company is both immoral and just plain stupid.
Or are you one of those "any job worth doing is worth doing badly" people?
Re:Fiduciary responsibility incentives? (Score:5, Insightful)
Options granted to employees are nearly always restricted in many fashions. For one thing, a percentage of the total grant is frequently vested over time - often 20% per year, giving a 5 year time period before fully vested. The company usually has the ability to call the options - that is, demand payment of the strike price - the average employee holding 20,000 options at $5 is probably going to be hard put to come up with $100,000 if demanded of him - most people would have to borrow on it, and you'll find few banks willing to loan against a privately held stock. The last time I checked, even a publicly held stock could only be borrowed against at 60% of market value. Many option holders would simply say "fergetaboutit" rather than go into debt on such a thing. Also, there may be peanlties associated with early "termination for fault" - i.e. you do something dumb and get fired and you lose all your stock options. Even once the options can be converted to tradeable shares, as a company insider many employees might be required to file public documents with the SEC announcing their intent to sell - now the world knows of their intent and can react accordingly.
The whole debacle about expensing them is about the biggest irrelevant effort made in a decade by the Financial Accounting Standards Board. In a public company, any investor that knows the difference between a put and a call is going to have his own rule of thumb for the value of an option - after all the thing is simply a promise that a share may, if desired be purchased at some time in the future - it's got nothing to do with the present day financial health of a company, and is a very hazy factor in the future potential value of a company's shares.
Expensing options is nothing but a big press deal - disclosure of options is all that is needed, and that is required to be done in publicly held companies already. A clear rule set of how they should be disclosed would be beneficial, but it seems no one is talking about that.
Truth In Accounting (Score:1, Insightful)
OK. So what.
What *REALLY* happened in that example is that Company X really only had $2 Billion in profits, but, because of current accounting rules, they were able to *LIE* to their shareholders, and claim that they actually had profits of $4 Billion.
It should also be noted that when companies do their taxes, they are able to deduct stock options as a business expense. What's really happening here is that companies want to have it both ways -- when doing their taxes they want to claim options are a business expense in order to reduce their profits (and the amount of tax they pay), but, when reporting earnings to sharelholders, they want to claim that options *ARE NOT* a business expense so that they can report the highest possible profits.
Companies do not want options to be expensed for one reason and one reason only: they are afraid of shareholder revolt once they see just how much money is taken away from the bottom line by the stock options given to the CEO and other top executives (who typically get far more options that the lower level employees).
The claim that the expensing of options will force companies to stop giving options to employees is totally and absolutely false. It is a lie. When companies make this claim, what they are really saying is "we're not going to give options to employees unless we can hide the true cost from shareholders."
Re:Consider SCO (Score:5, Insightful)
As an example, the corporation for which I work use to own a number of large facilities around the country. The land and buildings were owned outright so there were no loan payments to consider. A few years ago, all of the facilities were sold with the new owners granting a 20 year lease. This made the bottom line look really good that year. A few years later the rental expense is a significant impact that could have been avoided.
The executives who made that decision don't care. They made millions from it. Many of them took offers from other companies.
So, what's the solution? I don't know. I do know that executive stock programs have only made things worse.
Re:Fiduciary responsibility incentives? (Score:5, Insightful)
But lets put that aside for a bit. The real problem is that not expensing options is far too easy to abuse. Company grants options for 50 million shares. When options are exercised, company issues 50 million more shares. This doesn't impact the company bottom line at all. There is still no expense incurred. The only measurable effect is that earnings per share goes down. Then after several years of this, the company takes a one time charge to repurchase the stock they issued to cover the options.
That's not even taking into consideration the dilution of ownership caused by excessive option granting.
Value of Options (Score:2, Insightful)
Now after I sell you these options, they can change in value due to many things, such as stock price movement, changes in the financial outlook of the company, etc. The fact that I am now short call options to you means that I have a contingent liability to you on expiration to deliver X shares in exchange for the agreed upon stock price. I have potentially unlimited downside on this side of the transaction, if the stock price should skyrocket. But theoretically, I am on average compensated for this risk by the premium you paid to me to get these options.
Flip now to me being a company. You want options, and I give them to you, without charging you the premium. Had I gone and sold these out on the marketplace, I would have taken in P. This is not being expensed. If I want to unwind this position in the future, so as to remove the contingent liability, I'd have to pay P2 in the marketplace.
Whether or not you expense options, if you issue them at all, you are forgoing P. And in both cases, you have a contingent liability. Being short call options is potentially costly.
Can any company be short options on anyone else's stock in their investment portfolio and not have that liability noted on their books? I think not.
no, stock-options are NOT an expense (Score:3, Insightful)
See The Great Accounting System [mises.org]
The Stock Market, Profits, and Credit Expansion [mises.org]
Accounting for the Austrian School [mises.org]
Should Stock Options Be Expensed [mises.org]
The Financial Account Standards Board disagrees wi (Score:3, Insightful)
Where does that money go, hmm? If a stock is $50 per share today, and you exercise your option to buy that stock for $2, what happened to that $48?
Prevents Insider Trading (Score:3, Insightful)
With employee stock options, employees only have one trade...they get one chance to sell. The only risk of insider trading occurs when a stock is over valued. Their insider trade, of course, helps temper the rise of an over valued stock. I really don't see that much harm. The one trade reduces the losses of outsider investors.
The real power of options come with the fact that an employee can hold the options for several years with the value of the company rises. For most employees, the options are a long term investment strategy. For that matter, must companies have a policy that several years must pass before an employee is fully vested and can exercise their options. Are you really going to play your option on a one time blip in the market?
I believe, employee stock options encourage long term thinking. It is a far superior means for preventing insider trades than employee stock ownership plans where employees actually have their funds at risk.
In theory, employee options should temper employees interest in trading their company stock. Smart investors diversify their portfolio. It is plain stupid to have your salary, options and investments all dependent on the same source. Smart companies that offer options should strongly discourage their employees from owning the stock. Of course, there are many Enron's out there that actively sell stock to employees. A company that has the best interests of its employees at heart would discourage stock ownership by employees.
don't expense them!! (Score:2, Insightful)
After a while you learn that the numbers that GAAP gives you are pretty arbitrary. Conservative, yes, but still arbitrary. Many industries have their own "traditional" metrics that they report alongside GAAP, or in the "glossy pages" of the annual report. REIT's (real estate investment trusts, what I know the best) use FFO (funds from operations). Warren Buffet reports "pass-through" earnings for all his companies, even the ones he only owns a small portion of, even though GAAP says a holding company doesn't need to add in all minority interests. Etc.
The point is, I already "know" how to mentally adjust numbers for all this and create my own pro-forma results in my head. Reading these 10K's is not easy, they are complex and they bury stuff in the footnotes. But it's all there if you do your homework. Is it Microsoft's fault that CNBC reports the GAAP numbers? How about when a company takes a one-time charge and the numbers seem really bad, but the company is still in great shape?
The investors still have to study the financial statements. If you think a company is too complicated, don't invest! It doesn't make sense to throw more aribitrary junk into the financial statements. And options are not expenses, why treat them that way? Giving away something of value is not the same as spending money (hello, open source!).
I can see where Buffet is coming from.. this is the same guy who once said there should be a 100% short-term capital gains tax, just so people wouldn't churn the market so much. He's thinking that if stock options were expensed, companies would begin avoiding them, and it would create clearer, more transparent financial statements.
Yes, it would do that, but on the flip side options are a very useful compensation tool, and I don't think they are going to go away.
So, please, don't expense the options, just report them in the footnotes as usual. Please don't put more arbitrary non-cash numbers in the financial statements, they are confusing enough.
Michael's effot to turn /. into Salon? (Score:2, Insightful)
Before you consider this flamebait, consider what I'm saying carefully.
The proposed rules are stupid (Score:3, Insightful)
Options should be expensed when they are exercised. Not before.
The figure listed isn't necessarily a bad thing, and would be useful to project the outstanding value of outstanding options the copmany currently has, but it shouldn't be treated as an expense because the figure is misleading and hides the true operating costs of the company.
Reporting vs Expensing (Score:1, Insightful)
Options may eventually affect the financials of the company. In that sense they are liabilities. But they are being used as incentives and rewards for the recipients, like a compensation expense. But they are neither liabilities nor expenses. Trying to fit options into one of the basic accounting boxes is trying to push a square peg into a round hole. So don't. Make companies report the number of issued and outstanding options, and let financial analysts (and intelligent investors) figure out what to do with it.
GAAP already allow companies a lot of leeway in reporting their results. Understanding financial statements isn't rocket science, but neither should you just look at the bottom line (earnings) without understanding how they were calculated (viz Nortel).
Expensing is bogus - report the data and let the end-users decide what to do with it!
this might work... (Score:3, Insightful)
For a mature company, say MS to issue big gobs of stock to employees without expensing them and keeping the no longer unknown value off the books is a trifle ridiculous. At this point, this is just another form of compensation and as such should show up on the books as an expense. A.Lizard
Re:60% drop in earnings (Score:2, Insightful)
Today, the expense for options shows up if and when the options are exercised by the company either diluting the stock pool or buying back shares to compensate. Either way, this shows up in the financial statements. It just shows up at the point the options are exercised, as opposed to the current proposal to guess what their value might be and then stick that guess into the financial statements (and re-do the guesses every quarter).
The point is that we can either use real data (and get it when it happens), or we can use meaningless data earlier. It looks to me from the quote above that the guess produces a 60% error on average from reality.
I'd rather use real data.
Microsoft has been doing it for years.... (Score:2, Insightful)
Employee stock options are mentioned in point #3:
3) Convincing Employees to Take Less Real Wages:
Microsoft aggressively markets stock options to new employees in an effort to take wage expenses off the books. They also know that they can pocket the exercise price employees will be required to pay to take ownership of the stock. What also seems clear is that Microsoft is still aggressively marketing its stock option program to new recruits. To quote an email received, "I am about to begin employment at Microsoft and the stock option was the selling factor. Does your article overall state that it will be bad for me and will fail me in my retirement planning?" Is Microsoft fulfilling its disclosure obligations to its own employees, especially those that have put their entire 401K balance in Microsoft stock? This explains how 22 percent of Microsoft's massive cash balance has actually come from its own employees in the form of them prepaying their own wages through stock option exercise prices.
6) Stock Option Accounting: It is important to note that any discussion of stock option accounting must address two completely different and independent situations. The first is to analyze the impact of options exercised and already retired and the second is to analyze the remaining options debt outstanding. This study focused on both whereas most media coverage only focuses on the remaining options debt outstanding.
Options Exercised and Retired: When stock options are exercised, the options are retired as the employee takes ownership of the stock. The value of these "retired" options should not be a subject of debate. Upon exercise, the options are valued at the market price of the stock less the exercise price and the employee pays W-2 taxes on this gain, even if the stock is not sold. The company then takes a tax deduction for wage expense for the same amount. What is surprising is that not a dime of this expense is charged to earnings at Microsoft, which they could voluntarily do. This amount alone for 1999 should exceed $9 billion even though net income is only $7.8 billion.
Remaining Options Debt Outstanding: The remaining unexercised stock option liability is a completely separate issue and a debt just as real as the current stock quote, especially if half of the options are currently vested and exercisable. We all know that stocks can be over and under valued yet the market gives us a price on any given day and that is the price. The Black Scholes and related footnote disclosure is a great mathematical model yet has become nothing but a Trojan Horse for plundering the retirement system. What the Treasury Department and Federal Reserve might concern itself with is that this debt, $60 billion at Microsoft, has no interest cost that hits the income statement and increases $800 million with each $1 increase in the stock price. Simply put, Microsoft is somewhat immune to Federal Reserve interest rate hikes, which explains why the stock is increasing as the Fed raises rates and continues creating a Long Term Capital like debt pyramid.
Those who have significant stock investments in Microsoft think they are protecting their investments by defending Microsoft, but in reality they are like the Enron employee who bought Enron stock while management was 'broadening' their investments. Microsoft owners/management have been disinvesting in Microsoft for years under the guise of 'broadening' their portfolio.
Re:Warren Buffett's take on it (Score:3, Insightful)
Re:Fiduciary responsibility incentives? (Score:3, Insightful)
Then I hope you never have to manage a company. Managing a company is all about managing non-cash assets and expenses, because they will all affect your cash positions someday. The purpose of accounting is not to find out how much money is in the bank. You can do that just by calling the bank or keeping a check register. The purpose of accounting is to know whether or not your current practices are (a) healthy, (b) profitable, and (c) sustainable. It also helps you understand when you should expect your money, how much money you should be able to expect in the future, how much work you have left to do, what expenses you might have to fill in the future.
For example, if I win a housing contract that's $1 million dollars that I get paid up-front, I have gained NOTHING. What I have done is simply shifted my positions. I have $1 million more in assets, but I also have $1 million worth of liabilities (I still have to build the house - it's not a cash liability, it's a service liability). If I make the sale in December and then do the books on a cash basis, then it looks like I made $1 million profit, when in fact I don't even know if I'm profitable yet. I won't know that until the house is finished.
Likewise, if you are paying your employees in stock options, and not estimating the value of those options, you won't know if you're really profitable or not. If you wind up running out of options, you might find that the _real_ compensation package that they expect is 10x what you are paying them now, and that what you thought was a profitable operation was in fact just a drain on your "options" asset. However, since you were only doing books on a cash basis, you didn't see the true costs of doing business, and didn't realize until years later that you were truly unprofitable.
Likewise, if you don't factor in the cost of money into your operations, you might wind up making less than if you just stuck your money into the bank. In fact, the insurance industry is a giant play on the cost of money. Insurance companies actually often lose money on the premiums-vs-payouts, but make money by making loans off of the float.
So yes, there is more to accounting than just cash-flow, and it is vital to determining profitability.