Slashdot Mirror
Should Companies Expense Stock Options?
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?"
Yes I think companies should. It prevents insider trading.
How is the offer of options a "fiduciary responsibility incentive"? With an option, you have no downside, so you have an incentive to gamble all the firm's money on producing a temporary rise in the stock price.
Perhaps this was a typo for "fiduciary irresponsibility incentives"?
Can all that be translated to English please?
Huh? You say that is English? We're in trouble......
Mr. Casey acknowledged that "perfect accuracy isn't possible." But he added that "lots of other things in accounting are impossible to measure with perfect accuracy."
But at least other things in accounting can be measured with modest accuracy.
Options dilute the value of the company stock, and since shareholders are the owners of a company it only makes sense to list them as expenses.
I am for it...
Yes it is a good idea to link company and employee performance. But when something is given the value must be recorded.
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.
Options are issued from an "options pool". In any company large enough to be subject to FASB rules, that pool has already been set aside for that purpose. The dilution happened to the early investors (angels, pre-VC folks, etc.), which it was a small private company.
While I'm not as knowlegeable about financials as I should be, wouldn't expensing options also give companies a massive tax break, too? Seems like they would. They'd hit the bottom line, but tax savings would be tremendous, which would offset some of the "loss" proposed by doing this.
My understanding is that this would produce a clearer picture of the company's financial position. How could it be wrong?
I don't understand why this is even a question.
Aside from the fact that expensing options makes for more accurate financial statements, it reduces a company's tax burden, thus making them more profitable in reality (rather than just on paper).
I think it's a horribly dumb idea to pump up corporate profit on paper just so the tax man can take a bite bigger than your real profit out of your fake profit. I guess that's one of the problems with publicly traded corporations though - shareholders are often too uneducated to realize that long-term gain is more important than short-term illusion of profit.
I claim first use of "Error No. 0B" - or "No. 0B error." It'll be the new ID 10T!
Not a single company pays income tax without subtracting the value of their options first in order to lower their taxes. Why shouldn't they have to list this cost for their public statements, which is all the proposal is asking for anyway?
and it should be Federal law. otherwise, it is an unreported drain on companies' earnings and a dilution of the stock, screwing investors twice. three times, when you consider that the goons running these outfits think screwing investors twice in a row is OK, and you wonder what other scams they are running.
if this is supposed to be a new economy, how come they still want my old fashioned money?
The most incisive analysis of expensing stock options I ever heard was from Warren Buffett, who can surely claim to know what he's talking about in financial matters: "If options aren't a form of compensation, what are they? If compensation isn't an expense, what is it? And if expenses shouldn't go into the calculation of earnings, where in the world should they go?"
Chris Mattern
Will my stock be worth less when those options are exercised, en masse, by employees fleeing a sinking ship? If the answer is yes, then companies should expense stock options.
In fact, it's amusing that this even requires discussion. Options are like any other debt, except that the eventual cost of paying off that debt is unknown. Companies are required to report outstanding debt. Why should options be any different?
Slashdot is my Mercer Box.
Stock options don't have a clear value. Since you can't say "12,000,000 options are outstanding and excercisable, at a cost to the company of US$120M", you can't apply it as an expense. If you think Enron and Worldcom cooked their books, just wait until you see how the "expense" of stock options winds up being calculated. It's just as bad as requiring businesses to value their "goodwill" and take an earnings hit when it "goes down".
I think one of the major problems in this discussion is that the Stock Options for the CEO types (equivalent of about 1000 employees options, if you count them) can cause wrong and fraudulent reporting in order to sell off the stock.
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?
get 7 free Japanese lessons.
No it makes no difference to their taxes.
Its just a number reported on the company statement and accounted for in the profit figure. If you don't agree with it, just add it onto the profit to get the old number.
Excerpting from this recent article about the issue:
[The FASB board is the federal advisory board that's hashing out what should be done about expensing stock options.]
here is a mirror.
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?
Options are options, for the CEO or Account Manager they are all the same.
.... you end up in a situation where 44% of your profits are fake options tricks.
The problem is tech companies have been dishing out options instead of wages.
Those are only worthwhile if the share price rises,
The shareprice rises if the profits rise.
The profits rise if the costs go down.
Wages are costs, so the simple act of issuing options+lowered wages causes the labour costs to reduce, the profits to increase and creates a fake "growth" in profitability.
You can increase the profitability growth next time by issuing more options, and more and more and
..what the hell does this have to do with /.?
Okay, how are stock options currently handled? My understanding is that they appear on the balance sheet when the employee actually exercises the option. At that point the company has to buy the stock on the market, collect the option price from the employee, and eat the difference. Is that right? Or does the company just create the new stock on the fly when the employee exercises the options?
Several interviewees are asked the question, "How much is two plus two?"
Mathematician: "Exactly 4."
Economist: "Four, plus or minus ten per cent."
Accountant: (locks door, closes blinds) "How much do you want it to be?"
I've worked at dotcoms and now a large company which gives out stock options to its employees. Until i joined the large company I didn't realize the value of options (not a get rich scheme).
If companies have to expense options, they'll drop the option programs as the expensing will kill profitability. Therefore companies will nolonger give out options (MSFT has already stopped giving out options), and thus the major $$$ form of compensation will be salary, and salary does not keep an employee at a company for a long time, as you can jump ship to another company easier to get a raise than to ask mgmt.
Plus many companies spend big $$$ repurchasing stock on the market to keep up the stock price.
Lastly, if options are expensed then only the execs will get options and not the workers in the trenches.
HockeyPuck ---> .
Actually, there is more to it than just stock options. Due to the proposed accounting regulations, this may also affect employee stock discount purchases as well. Some companies are talking of dropping their employee stock discount plans.
Why is this of value? If you can consider that some people working for their company can get a stock discount of 10-15% instantly get that 10-15% return on their investment (although they do have to sit on their stock for a little while or face some penalities). Just think, overnight those discounts can disappear and you're left playing the market like a regular Joe.
How this new regulation would affect performance pay? Don't know. Hopefully they'll increase, but corporations might line their pockets instead.
Yeah, I know, greedy bastard, but I like "free" money. Lets me buy the "free" beer.
The company creates new stock.
The 'loss' is that the company doesn't get the full value of what that stock would be on the market.
It doesn't matter if they bought it or create it, they are still 'out' that money.
If they buy it from the market this is obvious, if they just create it the 'loss' is that they could have sold it to the market to get that same money.
So.. With that logic, I would presume everyone should use the write-off method because we never have a clear idea how much bad debt we should deal with? Do you follow GAAP? The point of book keeping is not to have perfect books (we all recognize there are some hard decisions about how to a good job of keeping books in order), but to have a reasonably faithful representation of what is actually occurring in the business. By treating stocks as something other than compensation when it is used for compensation and is not written as an expense, one is being unfaithful about representing the purpose of the stock. This is really no different than using Bad Debt Expense to tie the costs of written-off accounts receivable with periodicity. Just because I don't know what the value will because does not forgo me from trying.
Bel, the mostly sane.. "Of course I can't see anything! I'm standing on the shoulders of idiots." -- Me
The difficulty of expensing options should not be a barrier to accounting for them.
You can currently buy stock options in the market, why not use a similar system?
Stock options have value and should be expensed somehow, but to "only" expense the gains when the employee exercises and benefits leads to all sorts of counter-productive results.
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.
Who get stock options? That's the better question. I know accountants and CEOs are nerds too. But, how many CEOs or memebers of the FASB read Slashdot?
Have you Meta Moderated t
I know for certain that due to these moves, my employer is already looking to replace stock options with something else. For me that's almost okay because its somewhat useless for me to get the option to purchase something in the future while my employer gets an immediate write off. It would be nice to get actual stock, cash, or some other perk - but an option requires that I both wait AND spend money - not always a meaningful benefit by any stretch.
Never accept stock options in the place of pay. Sometimes they work out, but they're also pretty cheap to hand out for the companies that do it.
Anyway stock options (on publicly traded companies) are cheap enough in almost all cases that you can fund them yourselves if you've got confidence in the company, right?
-- The unsig...
If options have no value, why would anyone want them? The answer is that the value is their expected value in the future.
They do have a cost, just it is an unknown future cost. The problem with not costing it is the future liability is not accounted for.
The most common way of pricing an option is using the Black-Scholes Model. I don't really know much about the mathematical specifics of the model, but I'd expect that the "price" of an option as calculated by the Black-Scholes formula when the option was issued would translate into the "expense" that the company incurred. This is because it would be essentially equal to the amount that the people who were issued the options could sell them for- and compensation == expenses, to paraphrase the Warren Buffet quote that a previous poster brought up.
pi = 3.141592653589793helpimtrappedinauniversefactory7
Goodwill, to first define, is the premium paid for another company above what they are physically worth (buildings, equipment, patents, etc.) Therefore, if Co. A buys Co. B for $20 mil, and there are only $15 mil of physicaly goods, $5 mil is goodwill.
So the question now, is why expense (impairment is the technical term) it if the value of goodwill goes down? Because it is a consistent treatment of company especially intangible goods. If a company has a 15 years of a patent left to amortize, and for whatever reason it is invalidated, or maybe a new advance comes out making that patent obsolete,the comapny should properly impair the value of the patent, just as goodwill is now treated.
Two things we accountants like are comparability and consistancy. impairment of goodwill brings both of these to the table. After all, if SCO had any goodwill in the accounting sense, they should probably write off quite a bit of it, as they have likely drastically reduced the value of said goodwill.
thng
"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. "
Look at it from the shareholders viewpoint, would you want an estimate BEFORE you invest, or AFTER the options have been cashed in, your shares are diluted and you are screwed?
At the very least the accounts should have:
Profit before Options Expensing $2B
Cost of Options Expensing $3B
Profit after expensing options ($1B)
That way *you* are free to believe the company is making $2B profit, and *I* am free to believe that its a fake profit done by paying wages with options.
Every single additional stock dilutes my share of the company.
The only way to stop this is to buy back stock, which is a huge expense.
The REAL issue with whether options should be expensed or not is whether the diluted EPS captures the full effects of dilution through options issuance, or if there are hidden costs. There's a non-zero "option value" to the options (the choice not to exercise if the stock price drops), that is distinct from the "intrinsic value" (roughly equal to the strike price minus the current price). The argument is that this is presently not captured in the accounting regulations.
For more info on share dilution, check about.com's primer. There's also a section in there on common tricks companies use to hide dilution effects.
I personally don't think stock options should be expensed until the options are exercised. But even if we do, they certainly shouldn't be done the way that they are suggesting.
If I understand correctly, they take the value of the stock, assume a gain of 5% every year for 10 years, and then take that value and add that as the amount of the option.
That is ludicrous. They need a better way that is far more accurate. Writing options should actually not hit earnings at all... The company needs to just create new stock, and write options on them or reserve them especially for their employees. Then there is no cost except for the cost of the shares themselves when the company actually buys the shares.
From Microsoft's most recent filing, dated 20030905, Form 10-K [emphasis added]:
Am I reading that wrong? I understand the question is whether they should be required to expense options, which Microsoft is clearly stating that it is not required to do.
Slashdot is my Mercer Box.
If a company buys a tool or a building, they don't expense it because it has on-going value -- assets are held and used for the ongoing value they create. If a company buys paper or electricity, they do expense it because such goods are used almost immediately - expensible items are consumed or flow through the company. By that logic, options are an asset -- they have ongoing value and they are not consumed.
Warren Buffet is wrong, options are not like standard compensation -- options don't walk out the door like a paycheck does. Instead, options are intended to increase the productive value of the company's workforce - having options motivates employees to work hard. The longer the employee has the option, the more work they are likely to do. This makes the option more asset-like -- the longer you have a tool the more use you get from it. Thus, options have and create future value in a way very unlike standard compensation. In many ways, options create assets out of human resources.
The double-edge sword of options is that they do encourage the employees and managers to try to inflate the stock price. Although most managers and employees boost the company's stock price through honest, hard work, some decide to screw outside investors through financial gimickry. But expensing options won't eliminate this bad behavior - if the company still uses options, the employees still have incentive to drive up the stock price (by unethical means if they are so inclined).
Two wrongs don't make a right, but three lefts do.
Yes, they should expense options as expense. They shouldnt just give out thousands of share as paper money to employees. Reward employee with bonus or raises
I find it very interesting that this is even an issue. Regardless of whether or not the value (however it may be determined) of stock options are reported as expenses in the financial statements, stock market analysts and investors will be able to isolate and (if they so choose) ignore the impact of stock-based compensation expenses on the profitability of the company in question. This, of course, assumes that the company in question is intelligent enough to disclose such expenses separately on the income statement. It also assumes that financial statement readers are intelligent enough to interpret and assess the impact of such expense. I grant you that this latter assumption becomes increasingly tenuous, as the complexity of financial statements increases.
My personal opinion is that I would rather have such information disclosed separately, so that I could assess the significance of a particular company's stock-based compensation expenses, relative to its competitors. For those of you still caught up in the difficulties in measuring the value of stock options, I pose the following question: "How accurately do you think public corporations can measure the value of goodwill purchased on acquisition of another company?" The difficulties associated with the initial measurement of the value of goodwill (and any subsequent impairment in value) far exceed those of measuring the value of stock options.
C'mon people... let's admit our limitations. There are very few of us qualified to even form an opinion on this matter (not that that usually stops us) and those few will just be drowned out by all of the crappy assertions made by the rest of us.
/So how 'bout them HP laptops?
Options are nothing more than a promise to offer stock to someone at a fixed price in the future. If that fixed price is less than the market price, the company misses out on possible capital. This is the amount that people want to turn into an expense. How the heck do you account for that ahead of time? If you wait to account for it when the option gets exercised, it skews your earnings reports because of it reflects prior payroll, not current payroll. You can't just go back and drop it on the books for the date the option was given, because it'd be years before you could finally close the books on a given fiscal year.
In short, there is no simple answer for this question, so quit trying to find one and let the bean counters figure this one out.
Corporate expenses are incurred when a corporation buys something. A stock option, even when exercised, does not cost the corporation anything. It's a con game, to make less costly, high-growth infotech companies, which offer more options than industrial corporations, seem to cost more. Next they'll allow tax writeoffs for "opportunity costs", like letting Lockheed cancel its puny tax liability because it invested in laser missile defense instead of gas pipelines.
What else do you expect from the president who appointed the head of Alcoa, the practically medieval aluminum mining and manufacturing company, his first Secretary of the Treasury? Who proved unable to do anything to assist the bubble's soft landing, even when the rest of the White House would talk with him? The only thing President Vice President Cheney likes about tech companies is that they waste a lot of expensive electricity - so he'll make their finances as complex as possible, requiring his buddies at Anderson *cough* Enron *cough* Accounting to get their piece of the action if they show any green - cash - at all.
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make install -not war
I think that it would be a bad move to enforce these accounting changes. It is unfair to not just the employees, but the economy as a whole, as these options which are offered to employees add value to the markets, even if they cannot be traded in the immediate future. They help stabilize stocks which may otherwise have been screwed up because of speculative trading.
After reading some comments most here seem not to understand the issue.
Stock options does not mean you are compensated with stock. That is a common practive but options mean you will be able to buy the stock for a certain price at a given time, not that you HAVE the stock now. So they have not given you anything other then an agreement to seel at a certain price if YOU DECIDE to buy at the time of the option. I had to take a number of accounting courses as part of my CS program let me assure you if a company pays you in stock it is expenses already.
The knee jerk response to this is the matching principle which says you expense things in the accounting period that the expense is incurred, that is not always when its paid. So you say there has been no *real* transaction yet so there is no expense. Then you simply account for it like any other stock sale when/ip the employee buys the stock.
The problem is the rest of the accounting assumes an arms-length transaction. That is to say it works on the principle that things will be bought and sold at the market value, because all parties are aiming for their best interest. If you have a stock option you might be buying that stock for a much lower cost then the market value at that time. That effectivly means it is *costing* the company to sell you that stock.
The argument then is offering a stock option is incuring an expense because if your estimations are correct you will be selling for less its worth, why would someone want a stock option to buy for more then its worth? we can also guess that if we are way wrong and our stock goes through the floor nobody will exercise the option either.
If you estimate wrong you just make an adjusting entry later. The way I see it is that it probably should be an expense because I think companies tend to issue stock options with little conscience thought about the impact down the road, and or operate like the mail-in rebate scheme and assume a large percentage will fail to make good on the options, so they are suckering new hires to some extent.
Repeal the 17th Amendment TODAY! Also Please Read http://www.gnu.org/philosophy/right-to-read.html
I believe that the drive to force the expensing of options is rooted in a valid concern: currently, the impact of options on shareholders isn't properly disclosed.
That said, expensing doesn't address the real issue correctly.
What happens when an option is issued, from a financial point of view, is absolutely nothing. No expense is incured, no income is acrued, no increase in the share count occurs. It is a big zero from a financial point of view.
But yet FASB, wants to force a calculation of expense to be made that may or may not have any ultimate connection to reality and then to have that expense charged against the company in question's earnings in that quarter.
When an option is granted, the only material thing that happens is that a potential obligation to sell charges at a set amount over a set period of time is created. This leads to the possibility that the ownership "pie" of a company may be sliced into some larger number of smaller pieces.
When an option is exercised, a few things happen. First, off the company gets an infusion of capital equal to the option grant price times the number of shares granted in the option. Second, the existing owners of the company (read shareholders) see their ownership interest decreased due to the additional shares that have been issued.
Let me illustrate the above points: if a company has 100 shares outstanding, and I am given and then exercise an option to purchase 100 shares at $10 a share, then the following happens. First, the company gets $1,000 (100x10 = 1000) in additional capital. Second, the existing shareholders see their interest in the company cut in half. Whereas, prior to my exercise of the options, they had 100 shares and owned 100% of the company, they know own 100 shares and own 50% of the company. This is called dilution.
How would I address the legitimate concern for clearly and transparently communicating the potential impact of option grants on a company? Well, I would require that the earnings per share number be reported as if all option grants currently outstanding were exercised.
Currently, companies report a diluted earnings number, but it isn't "the offical" number. Let's make the diluted earnings number the offical one.
This is better than expensing for a couple of reasons. First, expensing only shows the impact in one quarter. It doesn't show the true impact of options being exercised, which goes on and on and on. Second, expensing is an estimate. There is no accurate way to estimate the "cost" of an option grant. Both of these points should be a deal breaker for any accountant. Accounting has at its bottom line rule that first, the number be accurate. This includes that expenses should be matched against the events that generate them. An option grant doesn't an impact, it only has a potential impact.
Yours,
Jordan
In my opinion, anything that leads to long-term stability of national and world economies is positive. It seems to me that there is a trend in the U.S. with large, quicky growing companies being irresponsible in the way they handle their finances. Because the stock market is speculative and therefore volatile during the fallout of these companies, a single company that folds can have a huge impact. I would like to belive that the market will eventually discourage this, but perhaps the allure of making quick profits and upper management being able to walk away with tens or hundreds of millions is just too powerful a temptation. In that case, I think it would be good for the economy and for the world for us to adjust the rules to moderate this tendency.
Ouch! The truth hurts!
Indeed, there is no necessary correlation between a company's stock price and its profitability or even its value to society. SCO is a fine example. The factors that drive stock prices can be completely independent of the factors that drive profitability. If incentives were based on profit sharing, or sales, or other tangible positive values, instead of stock options, the incentive would be to make the company profitable rather that to drive up its stock price. Accordingly, stock options may well create an incentive to breach fiduciary duties rather than to support them.
At the time when options are awarded, their value and expense to the company should be expensed based on Black-Scholes or some other acceptable formula. The reason why they shold be expensed at that time is that they effectively represent an expected long-term liability to the company.
However, when the options are actually exercised, the company should also expense any difference between the initial valuation and the actual profit made when exercised. If they are exercised with a smaller profit to the employee than their initial valuation, that difference should be added back to the company since that would represent a reduction of liability.
Similarly, when options expire without being exercised the initial valuation should be added back to the company's value as that expiration represents the removal of liability.
A combination of expensing options when granted and adjusting the expense when exercised or expired would provide the most accurate picture of their effect on the company's value.
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There is inferior bacteria on the interior of your posterior.
"What happens when an option is issued, from a financial point of view, is absolutely nothing. No expense is incured, no income is acrued, no increase in the share count occurs. It is a big zero from a financial point of view."
If you believe that then you are free to add the number back onto the profits to get what you believe is a real number.
However others may disagree, I for one.
I invest in a company for it to grow, so of course the options will reach strike price and will cost money, otherwise I wouldn't be investing!
But how much will they cost?
Management knows but doesn't want me to know.
The bigger proglem than expensing/not-expensing is the inconsistency that arises between how they treat options on their quarterly earning statements versus how they treat options when filing corporate income taxes.
Companies have said that they don't want to expense options until a standard method is decided upon but that hasn't stopped them from taking options as an expense on their taxes. What a bunch of liars.
At least some (all?) companies put the options in a footnote so you can easily determine "real" earnings if you're the expensing type.
I work for a company that used to give out stock options as a bonus. I have four blocks that were issued at different times. None of them were immediately mature and only the last block has a strike price that's below the current stock price.
So, while these options are theoretically an expense, only the last block really has any value to me and that's really the only (future) expense to the company. The other ones will likely expire (who's going to pay $60 for an option when the stock is $14?). It doesn't seem fair to me to call all of my stock options as expenses given that.
stock options should be free as in speech, and free as in beer, too. everyone knows those PHBs are BOFHs. if these companies knew what was good for them, they'd keep track of these options on a secure, reliable, open-source platform like mysql + apache. I for one am not about to let our new corporate masters bludgeon our rights with stock option rights management legislation.
I heard over on groklaw that MSFT was unfairly leveraging their mid-level business software unit for stock option dispersal in the MSFT-centric labor segment.
I mean, come on. this is just not the story to post on slashdot. what the hell?
That profit has carried them through some tough quarters. They really needed that money.
How do they profit? When an employee exercises stock options, say 30,000 shares at a strike price of $10, Amazon 'prints' the stock and pockets the $300,000.
Yes, this dilutes the stock. Many investors are oblivious to this 'action'.
Note that the stock options sold by 'regular' employees are not publicly reported like executives. People who started with 10,000-50,000 shares and had them split 12X. It adds up.
It prevents insider training.
That's nice. Fiat. The sky is purple. Why? Because I say so. No proof. Just based upon what I say. Would you prefer a prettier word than fiat? Try ukase. It's got a lot more umph in it than fiat (it can only be invoked by a Russian tsar) but it also doesn't require proof.
So we sit here watching your post. Care to explain what you meant? How about some proof? And please, don't tell us this is something in a magazine, or heard on a financial radio/tv show, and it's the only thing you can remember. That's worse than fiat.
An expense represents a transaction where the company spent money on something. Granting options cost the company nothing and no money changes hands. It is only when the options are exercised that there is something to account for. Options granted but not exercised should be treated as a liability because it owes something to the grantee.
When the options are exercised, how they are accounted for depends on how they are fullfilled. There are three possibilities:
1. If the company issues new stock, then again it no money changed hands. It should be reported so shareholders can judge how much their stock has been diluted by the newly issued stock.
2. Most companies have a cache of their own stock they aquired and never retired. This is a balance sheet item listed under owner's equity. If the company uses its store of treasury stock, then it essentially gave up an item from the balance sheet. The difference between the aquisition price of the stock and the sale to the option exercisor becomes positive or negative paid-in capital under owner's equity in the balance sheet.
3. Only if the company goes out into the market to buy shares, is there an expense. That expense is the difference between the market price and the option price.
In all three cases, the liability goes away.
no one really sees it in the financials, but it detracts from the bottom line none the less.
Options are being abused in my opinion, and requiring them to be expensed is simply a formal way of reporting to investors how the company is spending the profits. If I own stock in a company, I want to know how many options the executives are getting. Its very telling to me.
Is the juice worth the sqeeze?
"A stock option, even when exercised, does not cost the corporation anything. "
The accounts are for the shareholders. It costs the shareholder. The shareholder holds a share, its not the profit, its the profit per SHARE they care about.
So increasing the shares decreases the shareholders share of the profits, even if the company makes the same profit.
Fuck yes!
ENRON, Adelphia, Worldcom - pick the scandal and they have screwed lower-level employees with worthless options and tossed loads of cash at the top boys with the same tool: stock options.
If there were rules requiring the company to "expense" an option we would have some, small, check on the value of these things. As it is today, the value (or the right to exercise the option) varies greatly.
If the company had to expense options (and, thereby disclose the classes of options they provided) and they reported the options as a part of the annual report and 10-Q filings - both employees and shareholders would have some idea of the real status of these instruments.
Increasing the number of shares is dilution, which has been understood, and taken into account, by generations of stock buyers. Why should a shareholder's private expense be counted a corporation's expense? How does that give stock buyers any better info? In fact, it gives them worse, more muddled info, and a less manageable financial picture.
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make install -not war
There's no two ways about it.
The stock options come from Treasury Stock. Companies do not report purchases or sales from T-Stock activities as expenses or revenues. In which case the options should be expensed at their average value or leftover from an IPO (non-issued shares, extremely common) they they should be expensed at the IPO price. That way companies can still purchase shares at todays market price but only have to expense at the average price. Not a great solution but one that is a relatively fair compromise.
The reason that options are not expensed is because purchases or sales of Treasury Stock are "Zero Sum" items on the financial records of a company and therefore not shown as expenses or revenues, they balance the accounting equation out. You wouldn't see sales of stock to a person as a loss or gain, just as cash up, stock down. In this case it just happens that the company is selling stock for less than market value to someone that works for the company.
In GAAP/SEC accouting there are alot of situations that can effect cash that would not affect revenues or expenses, most of which are not abused and do not affect the company's daily operations. This is sadly one of those situations that does get abused.
In one debate I heard on this issue, the following example was used: Company X reported $4 Billion in profits last year. If they would have been forced to expense stock options, they would have only reported profits of $2 Billion.
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."
I have benefited from stock options in the past: not enough to be wealthy, but enough to give me a pool of savings to last the year-plus I have been out of work so far.
However, I favor stock option expensing, even though it would most likely reduce the number of options that are awarded to employees (since the company would have to bear an increased accounting cost for each option that is awarded). The reason is that it is more honest. The profit from exercising stock options comes out of the pockets of the stockholders who were suckered into paying full price for the stock! As a stockholder, I am annoyed that optionholders can "stealth" themselves from company expense reports, as is currently done.
Microsoft has a truly good idea, that I read about a while ago: issuing real shares of stock, not just options. This neatly avoids the entire debate regarding the accounting of stock options. Employees would be paid in real shares of stock, in addition to cash. This has all the benefits of encouraging employees to take a stake in company performance, as options do, and motivates employees to want to make the stock price rise.
Issuing real shares of stock would easily be accountable, and would also have added the benefit of being fair to all employees, not just the few who got in early and got the coveted "below-a-dollar" options....
Dr. Demento On The 'Net!
All through the dot.com bubble, I always wondered what forces frove CEO pay to be so high. After all, I could see why a good CEO is highly valuable, but not that valuable relatively and if you measured performance many were actually worthless.
Well more and more the answer seems like that their pay wasn't driven by true free market demand , but rather by the fact that companies could effectively pay an infinite amount of options - and it wouldn't show up anywhere on the bottom line.
I ask you, what would happen if you could go to wal-mart and charge it, but nothing would show up on your credit card statement?
Expensing stock options will not make executives more honest. You could ban options all together and the execs would find another way to line their pockets. The current problem with options and executives is that it creates a pump and dump incentive. Execs can show a good quarter or two, talk up the prospects and then dump their dump stock at a tidy profit. Fixing this really requires stronger corporate governance rather changing accounting regulations.
If the corporate boards really represented shareholder interests, there wouldn't be this problem since those boards would not allow compensation packages to execs that ran counter to the shareholder's interests. I'd start by banning board membership by anyone who works for the company in any other capacity, CEO included. Board members should only give execs options that are exercisable after several years and at a premium to the current price to account for inflation. This way the execs would have to create some lasting shareholder value to reap a windfall.
The expensing formulas can't capture the real value of the option. The only real way to figure out the value of the option would be to make them tradable and not expire on termination of employment. The proposed formula's are just a bean counters guess and will underestimate the value for companies that do well in the future and will grossly overestimate the value for companies that do poorly.
Furthermore, putting non-cash charges into earnings reports makes it really hard to understand the reports for those of us who didn't go to business school. It's already almost impossible to figure out what a companies cash flow from operations was from an earnings report because of all the stupid non-cash charges like goodwill amortization. Goodwill amortization is much like stock option expensing in that it makes the bean counters feel better but confuses everyone else. It's a lot easier for the dishonest to cheat when no one can under earnings reports and balance sheets due to the cluttering off them by make believe (non-cash) charges
While it is true that current accounting standards don't provide adequate protection and transparency to shareholders with regard to the impact that stock option grants have on a company's financial performance, the proposed rule will not correct this problem and at the same time do billions of dollars worth of harm to industries that traditionally use stock options as part of their incentive and compensation plans (i.e. the tech sector). Companies with stock option plans would immediately see large decreases in their reported earnings leading institutional and other investment elsewhere at least initially. Those options that companies were forced to expense could end up being worth significantly less than the arbitrary expense value. Long term, it is pretty clear that stock options would no longer be an attractive incentive device for rank and file employees - the immediate cost to the company's bottom line is just too great. Why now? The tech dog is only now just now starting to show signs of life again and now the government wants to give it a good swift kick? Go to http://www.technet.org/technet/employeestockoption s/ and let your congressman know how you feel. Also check out SaveStockOptions.org for related information and background.
I believe that the employee should be encouraged to improve the performance of the company. Profit sharing or other performance related compensation is a good idea.
I'm not even opposed to stock options.
I am opposed to people insisting that they have no cost, and throwing them around like such.
The big problem with stock options isn't accounting for costs in the financial statement, since issuing options, or even actual shares, doesn't cost a company money. What needs to be addressed is the effect of unredeemed options on share dilution. Don't force companies to expense options, make them account for the options as tenatively issued shares of stock, with the resulting effect on per-share revenue and dividends and the like. That would more accurately reflect the actual situation.
If stock options are not compensation, what are they?
If compensation is not an expense, what is it?
If an expense doesn't go on the profit and loss statement, where does it go?
Seems absurdly simple to me as well.
Companies that don't want to expense options
but are forced still will simply maintain
two sets of books, two earnings reports, etc.
Financial analysts that issue hold/buy
recommendations on stocks will simply track
the financial figures that don't account for
stock option expensing.
Are ordinary options issued to shareholders expensed currently?
Any analyst worth their salt will already be taking the dilution effect into their valuation estimates. Even if a company puts the expense in the analyst will make their own estimate anyway. Who's going to believe the company.
It is simply right from an accounting point of view - they're expenses so treat it accordingly.
Another thing. Opponents say that we should not treat it as expense because 'economic actions would be adverse'. Nonsense. What these guys basically are saying is: "No we don't want everyone to see that we are stealing your money". Well, stealing is bad and if you want to do it - be transparent about it.
I am a CPA by the way.
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.
I'm a nerd/CPA.
I don't socialize.
Nobody likes me.
I like computers.
Women hate me.
Life sucks.
I crunch numbers.
And basically wait for this life to be over.
But how do you simply and accurately account for this?
Is it just a loss when the shares are exercised?
Do you account for the unexercised option on the balance sheet?
When the stock price is high, the options are a big liability. When the stock price is low, they do not matter.
Are there any accountants out there who can help me out?
Religion is the main cause of atheism.
"Stock options are the most powerful incentive we have to attract employees," Andy Bechtolsheim, a founder of several Silicon Valley companies, including Sun Microsystems, told the demonstrators. "Why else would someone leave a large company and take the risk" of joining a start-up firm?
Without options, three out of four start-ups that succeeded in Silicon Valley would have failed, because they would not have been able to attract high-quality employees, Mr. Bechtolsheim said.
This does not make sense!
A start up is not public. They do not have to put out a report to the public every quarter. Expensing options do not have much of an impact on start ups.
And companies can still give stock options if they expense them. They just will not look quite as profitable on those quarterly statements.
Religion is the main cause of atheism.
Some people, myself included, will simply not invest in any company that does not expense options.
Other people will gladly take risks in companies that do whatever the hell they want in granting and expensing options.
Maybe one party will make money, maybe both, maybe neither; you pays your money and you take you place at the table WRT betting on risks/rewards.
Of course I realize that I have little chance of catching the next totally hot startup, but I've studied a hell of a lot of accounting and IMO a company is only as good as the accounting method they use; anybody throwing money around in the market who doesn't know GAAP and SAP and the difference betweent them is a fool- they still might be a lucky fool, but still a fool.
"Everyone is entitled to their own opinion, but not their own facts."
aantix.com Option probabilities; this should shed some light on the subject.
The reason why they shold be expensed at that time is that they effectively represent an expected long-term liability to the company.
No, they don't. A company can create shares out of thin air and hand them out to anyone without affecting its value. Current shareholders would take a hit from dilution, but this would be exactly balanced by the equity of the new shareholders.
Investors should be given all information regarding outstanding options and the company's policy for issuing them, so that they can analyze the risks of dilution. But treating them as an expense to the company just doesn't correspond to reality.
How to solve most of our problems: 1.Lots of nuclear plants. 2.Cure aging.
See The Great Accounting System
The Stock Market, Profits, and Credit Expansion
Accounting for the Austrian School
Should Stock Options Be Expensed
social sciences can never use experience to verify their statemen
And for anyone who wants to understand why it's good idea, I suggest you pick up a copy of Perfectly Legal by David Cay Johnston. It explains this and other tricks the richest 1% of Americans use to screw the other 99%.
If stock options are not factored into the
total of company expenses, or of total shares
outstanding, then it's basically "Monopoly"
money that can be converted to cash.
What crack-smoking Anderson Consulting accountant
first dreamed up this big pile of bullshit?
Since 2002 they've been expensing existing stock options and all the new grants to employees have been for real shares instead of options. How evil is that? Oh, wait ...
The greedy companies will just find other ways around to compensate w/o it showing up. CEOs, Presidents and Boards of Directors all enjoy a cozy "Boys Club" atmosphere and there isnt much that will change that attitude.
The Doormat
If you're not outraged, then you're not paying attention.
Yes.
It won't help.
Some bigger companies already changed policy to hand out restricted stock instead of options. I.e. instead of 5000 options, you get 500 (or whatever) restricted stocks that represent immediate value.
Costs the company the same (or more?), but does not have to be accounted for.
Nothing you posted has anything to do with the most important issue: STOCK OPTIONS ALLOW PEOPLE TO BUY STOCKS AT GREATLY DISCOUNTED PRICES.
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?
I don't read or respond to AC posts
- They should hand out shares instead of options. Just be honest with your share holders. Dilution is dilution.
- They should be more strict about tax deductions when giving money to non profits. For example, a non profit open source org is a way big corporations kill small software companies. They contribute to the non profit and get a tax deduction. Then they use the software for their services.You get free software for the deduction. Just the chump kids don't know who is getting the break! Got to be money in it somewhere or it would not be so popular!
- They need to stop tax deductions on depreciation. For example, a city sells an old subway system to a bank. The bank pays the city a million a year. But the subway system depreciates 10 million and the bank writes it off. Nobody want to upgrade the subway.
There is almost always a vesting period, and employees only get to exercise an employee stock option once...so, I can see merit in the argument that employee options cool the impulse for insider trading. In most cases, the strike price is determined by the hiring date of an employee. Employees do have leaway to determine when they sell the stock. There is a very strong temptation for employees to hold onto options until they leave the company. The longer you hold your employee option, the more valuable it becomes. The primary reason for employees selling options is to purchase things. This even holds for CEOs who might exercise a set number of options each quarter.
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.
I have been investing in stocks for nearly 10 years. I have several books on accounting, I read all the financial data for the companies I own, and I even read FASB's and stuff like that from time to time.
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.
about this, and I still can't figure out why this is on slashdot? If you are a financial geek, shouldn't you be at motleyfool?
The Kruger Dunning explains most post on
Expensing options is designed to do exactly one thing...eliminate them. They are the scapegoat for the excesses of the late 90's.
Its a crazy idea...expense an unknown amount that might never happen. When do you take it back? How weird are those balance sheets and bottom lines going to look in the future when times get bad, employees leave (or are laid off) and the bottom line gets a positive boost from the reversal of expenses for options?
We need business people to be actively concerned about a companies numbers 2-3 years down the road. One of the major problems with US companies is the incredible focus on the current quarter's numbers (and, of course, now Sarbanes Oxley is making that substantially worse.)
A better approach would be to make optioned stock be issued as restricted shares, with only 20%/year being unrestricted (and sellable and taxable.)
How far afield is an exec going to go screwing with results if he/she has to keep them up for many years for their stock to be worth something. Think about it after a couple of years of vesting options, they have a lot of money riding on the business doing well FOR 4 MORE YEARS.
Unfortunately, the government wants us to forget that the Congress and the White House of 1996-2000 couldn't (wouldn't?) enforce the existing laws/SEC regs that were on the books and this is how they distract us from that fact.
Suppose you were an idiot. And suppose you were a member of congress. But then I repeat myself. -- Mark Twain
I do think that at the very least, this is just outside the edge of being classified as news for nerds. Maybe news for opinionated libral nerds would encompass this story.
Before you consider this flamebait, consider what I'm saying carefully.
www.facebook.com/DareDefendOurRights
www.fairtax.org
It doesn't give any useful information to investors.
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.
Any treatment of options that requires estimating their present value is bogus. That's so speculative that it distorts the numbers. I' go for expensing them at exercise, while reporting the outstanding options. And for much longer required holding periods, like 3 to 5 years, at least for top executives.
Stocks are "worth" what anybody is willing to pay for them -- a stock quote is just the going market rate at that point in time. Companies that give shares of stock as options are simply agreeing to sell the shares at a pre-determined price, either absolute or as a percentage of the market rate (depending on how it works at the company in question or in the contract).
Imagine I have 3 million widgets which other people are willing to pay me $50. But I like you, so I say, "benzapp, you're doing a good job. I'll give you a widget for just $2 instead of the $50 that other people would pay for it." Now you can buy it from me and turn around and sell it to some sucker for $50. That's where the $48 magically appears -- it's not "gone" anywhere, it came out of someone else's pocket.
"You can never have too many elephants on your team."
Well, it never existed. However you could state that the $48 was money the company lost because it _could_ have sold the same stock for $50, with exactly the same dilution via increased shares. But this is a straw man because it has already granted the options years previously.
I find it hard to fathom calling a *potentially* money losing choice path an "expense". It sounds to me to be more of an "investment" with direct and indirect returns, neither of which are guaranteed. The direct return is the retention of valuable employees. The indirect return is never positive, and is the money lost because the stock that the employees excercise was not sold by the company at the market price.
Time to toot my own horn. My Blog has my account of the FASB meeting.
:wq
The article I wrote on the meeting is available here.
Don't Crease the Weasel!
So the question is, what's the most disadvantageous for Microsoft?
A company's stock trades for $2 a share one year and $50 a share some years later. The increase in price is, in theory, a function of the company's value increasing over that period of time due to the innovation and hard work of its employees.
For God doth know that in the day ye eat thereof, then your eyes shall be opened, and ye shall be as gods
Various posters here have said things along the lines of "you can't account for options because they may not be exercised, so you can't tell what they're worth". That is simplistic nonsense. I build corporate banking IT systems. Banks buy and sell options (on lots of things, including stocks) all the time. Of course banks value them, and treat them as assets and expenses. Exactly which accounting treatment to use to get the best, most precise, estimate of their value (without creating loopholes) is a matter for debate. But that's true of lots of things in accounting, and it is a separate question from whether or not you should do an estimate of the value of stock options when doing your accounting. Sean
Instead of ppl investing for companies that use sound accounting practices lets have the government regulate everything....what a great fucking idea.
Here is the thinking "I want to invest in a company but i want them to use my version of accounting...instead of promoting the idea to the company, i am going to have the government force them to do it my way."
stendec@gmail.com
If this isn't enough to help people calculate values, there are always OTC options -- they can call up a Morgan Stanley or a Goldman Sachs, CSFB, Lehman, etc, and ask for a quote on the 10 year options, or actually buy options from the bank to hedge their shareholders against the dilution effects.
there is no thing
what else could you want?
According to Bear Stearns, there would be a 60% drop in profits if the new rule were imposed. Think about it. Earnings in high tech companies are so dependent on stock options that these companies will "experience" a huge drop in profitability. Conversely, how can you support an accounting trick that buffs the profit of the industry by 150% (the reciprocal of a 60% drop)?
Bottom line. Profits are grossly overstated industry-wide. Why shouldn't we have accounting that reflects that reality? Why should we let this fiction continue? Are we going to forget the lessons of the dotcom bubble? Accounting tricks do work. And investors and employees can and are scammed by them. Finally, why do we need to fight so hard to get valid information about a company? It's just wasting our time which collectively is more valuable than that of a few company accountants.
See here for more discussion of this particular story. That's where I got the link BTW.
However, I do happen to know someone that just today got $1.4M through stock options as part of the sale of their company. But in that case, even tho the owners were big on the worker/owner model, they plan to go with LLC or something other than corporation the next time around, and will use a system of substantial bonuses based on revenues instead of stock options.
Obviously investors in public companies have the right to know how many options are being issued to employees and directors. That does not mean they should be treated as an expense.
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!
Nobody is FORCED to take their company public; they do so to obtain cash from outside investors. Naturally, no investor wants to put cash into something that won't pay back, and our country has established some "fair play rules" that boil down to
.03% of the 3000 largest companies in the country.) Inconsistent, hidden, or buried-in-footnotes numbers just are humanly impossible to work with. And they're against the spirit of public ownership of companies.
1) management's acknowledgement that they work for the new owners, as exemplified by accountability to a Board of Directors that is meant to protect the owners' interests, and
2) management will prepare honest and accurate accounting of what's happening to the company that they're running.
Options are only recently a significant part of a company's total financial picture, and so only recently have become important for investors to understand. After investors take a stab at whether, say, Palm One is going to make it or not -- neat ideas, good engineering, rapidly changing market and uncertain prospects -- they also have to consider that if the firm is financially successful, they mightn't get much to show for risking their funds.
My clients have a few billion dollars, mostly middle-class retirement funds, at stake. They expect reasonable risks and a fair chance at a good result. The elementary math of investing is that many investments are losers, or have a very modest payback. It's the relatively few that succeed that make stocks good investments. If those few don't actually pay you -- unknown options give half of it to employees -- then the whole deal turns sour.
As many posters have mentioned, expensing options doesn't change the CURRENT working status. As an investor, I'm happy to see creative carrots for important employees, but I absolutely MUST have a good feel for what fraction of the company's success is committed to somebody other than me. The challenge is for me to make a decent swag at the company's future earnings that my clients will get. (My clients own about
I strongly support using options as an incentive to employees, but I also strongly support a standard, consistent way of accounting for them. If firms don't want to provide investors with a consistent, "generally accepted" picture of what they are doing, they shouldn't be offering stock to the general public.
"Inquiring Minds Want to Know!"
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
Tech Public Policy stuff
Stock options are a fiduciary responsibility incentive because it links the fate of the option holder to the health of the company. (as measured by stock price) The downside with options is the loss of sweat equity on the part of the recipient if the option proves to be worth nothing and the dilution of equity if the option proves to be worth something. If you as executive gamble all the firm's money on a *temporary* increase in stock price then you're the type who would otherwise just wire the firm's money directly into your personal account in the Grand Cayman Islands anyway. What you're supposed to be doing is risking the firm's money on a *permanent* increase in stock price. You know, adding value? Now, you might argue that options give people incentives to make risky decisions. And you would be correct in that. Such stocks have correspondingly high betas. But putting money or sweat equity behind innovation is itself extremely risky.
For God doth know that in the day ye eat thereof, then your eyes shall be opened, and ye shall be as gods
You are right. I should not have said "sell." I thought I had said "exercise." Generally employees cash in by exercising the option then immediately selling the stock.
The employee options I've had in my life have all been pegged to employment. So I would have the options from the day I joined the company to the day I left. I would have to exercise the option within 90 days of parting company with the company. NOTE, I keep being laid off in recessions so all my precious employee options have proven worthless to date. For that matter, generous option packages for employees makes mass lay off events very tempting for employers. Laying off employees in recessions automatically eliminates all of the options with a strike prices less than the current stock market value.
The really nasty downside to employee options is that, by being pegged to the employee lifecycle, they end up creating a double whamming for those employees laid off in recessions. The employee loses the paycheck and their retirement funds in one cruel stroke.
I used to be in favor of employee ownership, until I realized that employee ownership magnifies the risk of the employee. Employees need to diversify.
BTW, have you noticed how employers were more than willing to inundate new hirees with options at the height of the stock boom, but make a big deal about protecting employees from the risk of options after the market correction...now that options are a good deal again.
There are people in this world - those traders on Wall Street - who know very well what the value of options are.
They buy and sell options every day for real money, and they don't pay a cent more or less than they're worth. These guys get paid real money - in the hand - for trading options. Do you think that money's illusory as well? Do you seriously think that banks pay their employees for making illusory profits?
Read my lips - options have objective and tangible value, which everyone who participates in the options market agrees on (they just think differently about the future price).
Anyone who says differently either doesn't know what they are talking about, or is just blowing smoke.
You can go around in circles as much as you like but those are the facts.
Now consider this:
The USA is the only major country that does not expense options
Despite that, a number of US listed companies (start-ups and others) that sell to Wall Street DO expense options. If they didn't they would have zero credibility.
So if you believe options are cost free, then you'll have to accept that both people who know (ie. Wall St, London etc), and the rest of the world think you've got rocks in your head.
And while a lot of people in the US might agree with you, you're just a member of a large group of people who are living in la-la land.
More seriously, the improper treatment of options is one of the largest on-going fiscal scandals of the past 10-15 years. Options transfer money from public shareholders to insiders.
I like you, so I say, "benzapp, you're doing a good job. I'll give you a widget for just $2 instead of the $50 that other people would pay for it.
All you did was sell benzapp a widget with $48 in cash taped to it. That $48 was a real expense.
You could have saved benzapp the hassle of reselling that widget (and thereby reducing your other widget sales by one) by simply handing him that $48 cash without taping it to a widget purchase. The final result is identical.
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- - You can't take something off the Internet! That's like trying to take pee out of a swimming pool.
You could have saved benzapp the hassle of reselling that widget (and thereby reducing your other widget sales by one) by simply handing him that $48 cash without taping it to a widget purchase. The final result is identical."
This is an inaccurate picture of stock options. The second part is obviously clear, if you give him $48, you have an expense of $48, but that is not the same as an option with a strike price $48 below current market.
With options, you have four factors:
1. The number of shares granted.
2. The strike price (at or below current market).
3. Vesting schedule (when the options can be exercised).
4. Expiration date (usually 10 years).
So lets say we get a grant of 100 shares at current market (say, $10/share). They will vest at 25% per year (after one year, you can exercise 25 shares, after another year, another 25, etc.) and expire after 10 years.
Now tell me, how much of an expense shall I record in my books? Who can say what these options will be worth? No one. We may hope they will be worth something, but they might not be.
If you leave the company before they vest, you get nothing.
If the stock price stays at or below $10 from the time they vest to the time they expire, you get nothing.
Let's say at year one, the stock is now worth $15, you can then exercise the 25 vested options and sell them for a total profit of $125 (minus tax). At that time, if the company does nothing else, the following will happen:
1. The employee will be $125 richer.
2. The shareholders will have had their stock diluted by 25 shares.
3. The company will not have incurred any real expense whatsoever.
Many companies will buy back stock from the open market to compensate for the dilution, which is a reported expense today.
The point is that your example is just plain wrong. It is not at all the same as just handing them the money. With options, they may well end up being worth nothing.
Note the practice in some companys of revaluing under-water options is another matter though. There are legitamate reasons for revaluing employee share options such as 9/11 but that is about it.
See my journal, I write things there
Assume company X has $100 million in actual cash profit one year, but grants options to employees that the SEC makes them record as $100 million of expense. Does that mean they did not make a profit, and thus do not have to pay any taxes on the cash?
The latest Slashdot meme.
The primary reason that I see to expense stock options is to eliminate their current preferential treatment relative to stock *grants* and wages. Under the current system, stock grants and wages are expensed but options are not. Further, stock earnings are taxed as capital gains (thus lower than wages). As a result, companies replace wages with stock options at ridiculously low valuations for top executives.
Since stock options are riskless (if the stock price falls, one simply loses the ability to exercise the option; with granted stock, the executive notices both increases and decreases), they do not serve the claimed purpose of encouraging executives to care about company performance. By contrast, a stock grant that can only be sold after a certain measure of time encourages long term performance. Options encourage the taking of risks to increase stock price without penalizing the possibility of decreases in stock price.
This is not to say that your objection is not without merit, so here is my proposal: instead of using Black Scholes to value the options, use the current stock price (minus any exercise cost). If the option is not exercised, mark it as income in the new accounting period.
In regards to startups, I'm not sure what your worry is. Startups are not publicly traded, so those who invest in them have the direct contact necessary to properly evaluate the accounting. Further, startups are perfect places to pay in stock grants rather than options. Options are just extra paperwork. Unless the company takes off, both grants and options are just paper.
stock option grants do not, in principle, influence cashflows(otherwise it would have been impossible not to expense them). on a practical level, they influence where the cashflows go, i.e., in management's pockets instead of the shareholders'. even when used in a startup they should be reserved against, but I agree that it would be impossible to expense them right away.
one of the key issues, tough, is:
at what strike price options should be granted?
the strike price of an option is the price at which i have the possibility, but not the obligation, to receive the underlying stock. if the stock price is already ahead, the option is "in the money", meaning that if I could exercise it now, i'd make a gain.
since options can be exercised only in future dates, intereest rates come into the picture, but broadly speaking, we can say:
options granted at prices below or close to the going price of the shares = cokmpensation;
options granted at prices higher than the going price of the shares + interest at going rates = incentive.
there was a going joke in the good ol' days: the whole of Enron management goes to a strip joint to celebrate another good year of hard work. one of the ladies, after a bout of pole-vaultin', goes on all fours to one of the guys, looks him in the eye and says " I'll do anything for you. absolutely anything." and quickly, he answers:
"reprice my options"
( repricing is a practice by which companies lower the strike price of the options granted, whereby making them much more valuable)
"If a boss demands loyalty, give him integrity. But if he demands integrity, give him loyalty." (John Boyd, 1927-1997)
Options and grants should both be expensed the same. Under the current rules, they are not. If options are expensed, then they have the same status as grants. Further, options are currently expensed for tax purposes. What this does is make the same expenses that give tax breaks included in the accounting. It may not be perfect, but it is better than the current system.
The natural corollary of your argument is that we should do things the other way: rather than mark them on the accounting, companies should not get a tax break for an option (or grant). It should just announce the stock dilution (twice for options: once at grant, once at exercise; stock grants are granted and exercised at the same time, so this is not necessary).
The point is that your example is just plain wrong.
:)
It was not my example, it was the grandparent's example. If there is a problem with dragging widgets into a stock discussion then blame him
I don't think you actually said anything in my post was wrong. At worst you said my post was irrelevant because the grandparent's analogy was bad.
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Confucius say, "Find worm in apple - bad. Find half a worm - worse."
What you are essentially claiming, is stock options are frauds. The $50 per share is just bullshit, and Johnny Corporation is saying fuck those suckers, we are giving it to you for $2. After all, caveat emptor.
You aren't thinking about this. That $48 necessarily comes out of the company's profits which are used to buy stocks at the time of vesting to cover the options that can now be exercised.
This is why stock options do not necessarily dilute the holdings of existing shareholders! This is also why according to FAS123 guidelines, the expenses is incurred at the time of vesting, not the time of granting.
I don't read or respond to AC posts
Do you realize that on average, less than 50% of stock options are ever exercised? Do you know why? Because it onder to qualify for incentive stock opion benefits you have to issue the options at FMV on the date of grant.
Further, you have to HOLD the options for at least 1 year to gain the profit tax free, so a same day sale is discouraged.
DO you really think that it makes sense, considering the above facts, to count stock options as stocks at the moment of grant and thus dilute everyone elses holdings, even when MOST of those options will never actually become stock?
I don't read or respond to AC posts
...in fact, Microsoft is an excellent example of how this kind of accounting distorts reported earnings.
Also: MS is an excellent example of a company which used option compensation FAR MORE than most companies (during the '80s and '90s).
Also: Beginning in September 2003, Microsoft employees began to receive shares of Microsoft stock rather than options to buy them.
Also: The issue is not how many options are outstanding. The question is whether options are expensed when issued. MS isn't issuing more.
Also: Companies that pay employees with options (including Microsoft before 2003) DO expense options when they calculate their earnings for tax purposes. It's only when they calculate them for shareholders that they lie.
While MS's financials look good today, for most of the company's history they would have been terrible without phony accounting of stock options. Through much of the '80s and '90s, a typical MSFT employee was getting $100,000 in salary and $300,000 in compensation derived from the sale of stock options. Not expensing these stock options enabled the company to list only one quarter of their actual compensation on their expense line in calculating their earnings reported to shareholders.
So, while they were showing massive profits to shareholders, their "very steady earnings" were in fact "very steady losses." In fact, these very steady losses were (quite accurately) reported to the IRS. Which is why they were paying practically no corporate income tax during those years.
Eternal vigilance only works if you look in every direction.
...these companies are already expensing options for income tax purposes.
Eternal vigilance only works if you look in every direction.
...taxable earnings would not be lower because they ALREADY expense options for tax purposes.
In fact, one of the proposals for remedying the problem is to simply require companies to use the same accounting methods for reporting to shareholders and the IRS. (Hint: None of them would use stock options if they had to use the same expensing methods.)
As far as MS is concerned, they stopped issuing stock options in September 2003. So, their current earnings are real. But your analysis would be valid for the '80s and '90s. In fact, your analysis would significantly understate the effect. MSFT would have been reporting losses through most of that time period had it expensed its stock options in the same manner as it expensed them on tax forms.
Eternal vigilance only works if you look in every direction.
If FASB wants to pass a rule, they should standardize the terms that can be offered on employee options, and then make the options tradeable. Then nobody will have to wonder about what they're worth. You just mark them to market every day. The other benefit would be that employees could (potentially) obtain benefit from their options even if the options are not yet in the money.
Publicly traded companies and private start-ups have completely different needs with respect to options accounting. For publicly traded companies, expensing options is desirable for providing better information to smaller individual investors. For private start-ups, accurate expensing is not feasible and not necessary because individual investors should not, usually cannot, and mostly do not invest in such companies. For public companies the leading issue is to make the financial statements as helpful as possible for outside investors with limited resources to make a quick decision about a stock. If you have the time to read all the footnotes and run your own BS model to value the options, you don't need to rely much on the income statement treatment of options. Smaller individual investors need to rely on income statements to a greater extent. Failure to expense options means such investors might miss the fact that a company's apparently high performance was purchesed by high compensation of executives or that the company was being looted by executives through excessive stock option grants. For publicly traded companies there is much more information about the volatility of the underlying common stock (a key variable in any options pricing model, such as BS. Privately held companies have insufficient common stock pricing events for such a volatility estimate. In addition, the outsiders investors are typically sophisticated angel investors and/or venture capitalists, mezzanine investors, or friends and family investing based on trust of the insiders. This is a vastly different scenario. At some point the investors might want the company to switch to expensing options
This year IBM shareholders voted to expense stock options. The Board of Directors recommended voting against the proposal for expensing options as it obviously effects CEO compensation but the shareholders wanted it anyway.
As other posters have pointed out - this effects other employee stock programs such as some Employee Stock Purchase Plans depending on how the company sets them up.
I think this would be a great idea. But FASB just creates standards for accounting. The SEC decides what is considered a tradable security and what isn't (given the history of options, I suspect approval is not that hard to achieve and the CBOT below might already have it). And even once they approve it, someone has to set up the market.
That leads us to who actually is setting up markets on stock options. Namely it is the Chicago Board of Trade (CBOT). Only problem is that they usually only have options through the year (one expiring every quarter and perhaps a few monthly ones) and a few that expire up to three or four years down the road (the "LEAPS" which always expire in mid-January). So no options in the vital 5 to 15 year period. That might change over time. The CBOT is slowing extending the time of its LEAPS.
That means derivatives dealers (like J.P. Morgan or Citibank) actually make the trades. These markets are lower liquidity (hence either the employee options are untradable for that reason or would require a sizeable transaction fee to sell off early.
I think also a number of companies like having their options be untradable. Yet more incentive for the employee to stay with the company if you can't bail prior to vesting.
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.
My employer already feels they have to do this, so they stopped giving options. We are in the process of talking them in to starting again.
I'm pretty sure that VC's (venture capitalists) and most Angel investors (people like paul allen that have wheelbarrels full of money and finance other companies) don't need accounting rule changes to figure out the value of stock options. Since they are the major funders of private companies, they will likley continue to favor giving stockoptions to the employees of the small private startup companies that they fund...
However...
Since many private companies want to go public eventually, in the year or so run-up to their IPO (initial public offering), they usually want to normalize their books (startups tend to have wacky books because of various loans and stock warrants that they have to issue along the way). Employees that are hired during this run-up time are likely get screwed in the stock-option lottery since they usually want to show some profit at this time (or at least less of a loss, since the 90's dot-coms extremes are out of fashion). This might make it more difficult for a hot startup to make the transition to a public company making it hard to attract high-quality employees at this time...
Since the IPO is the primary vehicle for these early stock-optionees have to make their expected stock-option windfall, it's still somewhat a concern to early employees if there are additional hurdles to make an IPO more difficult (e.g., I've got quite a bit of startup company wall paper already, making it more likely for stock options to be wall paper will certainly makes it worth less to me in an expected return on investement sense).
This may tend to more small startup companies that get bought by big companies (no-ipo exit strategy), and fewer companies that start small and grow up. This would probably be counteracted a bit by bigger companies just paying in restricted shares (or cash bonuses) and small startups being the only way to "roll-the-dice" and gamble on a big payoff.
In the end, these rules will probably change the company landscape a bit (fewer brand-new medium size companies), and force workers that want the big stock option payoffs to take greater risk (kinda like the share holders need to). This would probalbly end the day of money for nothing (e.g., getting lucky) with startups...
I'm sure many employees (remember senior management are still employees) don't like these results since it will probably lock in the have-vs-have-not balance as they only people that want to take this new increased risk are people who have already won the lottery, but that's life...
And just how many questions can we pack into one /. story?
Magic 8 Ball says:
Outlook uncertain.
I have been told that Oracle Corp is already planning to phase out the Stock Option, and Employee Purchase Programs for just this reason...
Need I say more.
Power Corrupts,Absolute Power Corrupts Absolutely, leaving one person(group)in charge is absolutely corrupt.
Companies should expense stock options. As a compensation expense, this would reduce earnings thus decreasing taxes. Since no cash is involved, the cash flows would be increased by the amount of the tax savings.
In addition when employees pay taxes on thier stock options, the company gets credit for the taxes that the employees pay, however this only shows up on the statement of shareholder equity.
If you don't want employees to increase short term earhings over long term company viability, then the stock options should be structured so that employees will not think short term.
Companies sell options to shareholders and others --- in this case the options are called warrants. The investor gets a warrant, the company gets cash.
The point of expensing is to account for the cash the company doesn't get. If the company gave the employee cash, and the employee in turn bought an option, there would be no problem with the accouting. It's the *grant* of an option in exchange for labor that necessitates expense being recorded at some point.
Stock options (and issuing new shares) is not an expense. It is the dilution of existing shares. In short, it is share-inflation.
social sciences can never use experience to verify their statemen
social sciences can never use experience to verify their statemen
he's more stupid than the people at FASB. The word "smart" does not belong in a sentence with him and FASB.
social sciences can never use experience to verify their statemen
Ah ha! Accrual. That answers my main question. The option is basically held in trust for the recipient, so they don't have any tax issues at the time of granting. Granting and expiration only affect the company's position. I knew it couldn't be as stupid as I was making it out, but I just didn't see how.
I am very well acquainted with this debate, and nothing new was presented in those links.
Unfortunately, you, and none of the other fucking idiots who have responded to my posts can satisfactorily discuss the significance of optionees purchasing stocks for LESS than the market value. In my opinion, it shows how thouroughly corrupt and decadent our financial has bins have become, that they cannot appreciate the significance of artificially created money.
And once again, I ask, have you ever read the FAS123 guidelines? How about even the APB25 guidelines?
The fact remains that no one who is professionally involved with financial reporting is suggesting stock options should NOT be an expense. Who are we supposed to believe? Some fool on slashdot who can make nothing but unsupported assertions? Or the fine people at FASB and the Securities and Exchange commission.
I don't read or respond to AC posts
If optionees purchase stocks for less than market value, so what? If the company actually bought stock from the open market to allow for such, then that is an expense. If they simply dilute the number of shares, then it is not an expense.
Perhaps you are too stupid to understand what an expense is. An expense has to be made using an asset. Unless the company actually owns shares (via purchasing), then the shares are not an asset to that company. They represent ownership in that company. By printing out extra shares for their company, they are not incurring an expense, because they are not using an asset.
Because you are apparently too stupid to read what I linked too, I'll quote from it again:
I'm sorry if you -- and the morons in the State you worship -- are too stupid to understand what is an asset and what is not. Outside of those shares a company actually purchases on the market, it's own shares are not an asset to that company. It can print out shares at will without incurring any expenses. What it is doing is diluting ownership, and using those newly printed shares as a form of compensation (it may even give them to employees for free). It doesn't matter whether the employee pays 0% or 100% of the price of those shares (via his or her option). The company still has not -- not one iota of it -- incurred an expense.
social sciences can never use experience to verify their statemen