Saturday, November 13, 2004

John Berlau’s column on stock options expensing (“Stock option expense jousting,” Nov. 7) is incorrect and misleading.

The prime argument behind expensing has little to do with some international conspiracy theory Mr. Berlau imagines. Instead, it is almost totally based on the fact options have value for companies, employees and shareholders — a value not currently reflected in companies’ earnings statements.

Unfortunately, Mr. Berlau didn’t address that issue, choosing instead to tilt at “unelected accountants.”

Options have value to companies, because firms can by using them reduce the cash they spend on payrolls. On the flip side, many employees have been willing to trade cash salaries for the potential riches of options.

From the shareholder perspective, options have value partly because they dilute present shares. But they also have value because of the cash companies often (some might say nearly always, in the long run) spend buying up optioned shares.

Sure, using options gives some American companies a competitive advantage. If you can take 40 percent of your costs off the books through an accounting sleight of hand, how would that not provide an advantage over competitors? Jeffrey Skilling, former Enron chief executive officer, told a congressional committee, “You issue stock options to reduce compensation expense and therefore increase your profitability.”

Requiring companies to estimate that value is neither radical nor inspired by international convergence. How best to recognize stock options’ value has been debated for decades. FASB wanted to require expensing in the mid-1990s, but Congress stepped in at the behest of the tech lobby. Congress later weighed including an expensing provision in the Sarbanes Oxley bill, but backed off — again at the tech industry’s insistence.

Many would argue the truly radical notion is that a company need not report an expense on its income statement. While using options isn’t linked to all corporate scandals, the concern among many corporate reformers is that options encourage disasters like that at Enron by focusing managers on short-term stock movements rather than the longer-term interests of the company and its investors.

Indeed, support grows for options expensing among investors and companies. Some 500 companies now expense stock options, including tech and Internet heavyweights such as Microsoft and Owners of a majority of shares have told both Intel and Apple they want options expensed.

In addition to these broad-brush inaccuracies, there is a more specific one. Mr. Berlau says FASB’s proposal would require companies to “expense an estimate of the future value of stock options.” That is incorrect. FASB’s proposal would require companies to recognize the fair value — not future value — of their options grants on their income statements.

Fair value is an estimate of the present value of those options, in view of factors such as their likely cancellation before they are exercised and the odds the company stock will rise above the options’ exercise price.

We can debate whether FASB’s proposed formulas for determining the fair value of stock options are accurate or appropriate or need to modification.

We can also question whether it is at all appropriate to use fair value. Indeed, some who favor expensing favor a mark-to-market method, which essentially would require companies to determine a value for their outstanding options every quarter by comparing their strike price with the stock’s market price.

We can also debate whether it’s a good idea to try to converge accounting standards.

But to suggest convergence is the primary reason for the push on options expensing is alarmist at best. It is simply wrong to suggest there are no compelling reasons to require or support expensing beyond a Star Chamber of unelected accountants.


Staff reporter

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