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Should Companies Expense Stock Options?

Posted by michael on from the lottery-ticket dept.

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?"

3 of 418 comments (clear)

  1. Warren Buffett's take on it by Chris+Mattern · · Score: 5, Informative

    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

  2. Not IF but HOW by schwaang · · Score: 5, Informative
    Realistically, options are an expense and pretending otherwise on the balance sheet is just gamesmanship.

    Excerpting from this recent article about the issue:

    The most potent criticism of the board's draft proposal to expense options when they are granted, came from an unlikely source: Mark Rubinstein, a finance professor at UC Berkeley's Haas School of Business, who helped develop the method.

    "I was one of the inventors of the (board-proposed) model, and I say: Don't use it. It doesn't work," Rubinstein said. Companies should have to expense only the amount that an employee profits after he exercises the option to buy the stock, Rubinstein said.

    That came as a surprise to the FASB board members.


    [The FASB board is the federal advisory board that's hashing out what should be done about expensing stock options.]
  3. Yes "duh". by nodwick · · Score: 5, Informative
    Uh, no. Stock dilution happens because the number of outstanding shares changes. The earnings and growth numbers that are used to valuate shares are calculated per outstanding share, so any change in shares outstanding creates dilution. Look at any company's 10K or 10Q; they'll have two lines listing earnings per share (EPS) and diluted EPS separately for precisely this reason: diluted EPS is what the company would earn per share if all the options were suddenly exercised.

    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.