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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?"
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.
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.
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?
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Ya, I thought the same thing. It forces one to question if the submitter even understands what an option is.
I've had long discussions about options with my friends. I finally realized the only sensible objection to stock options. And that is they have no impact on the cash position of the company. When a company is small or newly founded, it doesn't really make sense to value options, as at that point the cash poisition of the company is the overriding concern; this allows start-ups to offer compensation that, while not equal to that of larger companies, offers a tremendous possible upside to employes. Once cash flow is no longer really concern, it's convenient to continue to give options, as it doesn't count against the income statement. At this point, Warren Buffet's words quoted elsehwere (if options aren't compensation, what are they; don't we expense compensation?).
In short, options for start-ups make sense, and no one really cares what the GAAP earnings are-- cash flow is much more important. For established companies, cash flow is often difficult to relate to the success of a company, so using GAAP earnings makes sense, and options should be expensed. And I have no idea what "fiduciary responsibility incentives" are, and the submitter doesn't either.
Options granted to employees are nearly always restricted in many fashions. For one thing, a percentage of the total grant is frequently vested over time - often 20% per year, giving a 5 year time period before fully vested. The company usually has the ability to call the options - that is, demand payment of the strike price - the average employee holding 20,000 options at $5 is probably going to be hard put to come up with $100,000 if demanded of him - most people would have to borrow on it, and you'll find few banks willing to loan against a privately held stock. The last time I checked, even a publicly held stock could only be borrowed against at 60% of market value. Many option holders would simply say "fergetaboutit" rather than go into debt on such a thing. Also, there may be peanlties associated with early "termination for fault" - i.e. you do something dumb and get fired and you lose all your stock options. Even once the options can be converted to tradeable shares, as a company insider many employees might be required to file public documents with the SEC announcing their intent to sell - now the world knows of their intent and can react accordingly.
The whole debacle about expensing them is about the biggest irrelevant effort made in a decade by the Financial Accounting Standards Board. In a public company, any investor that knows the difference between a put and a call is going to have his own rule of thumb for the value of an option - after all the thing is simply a promise that a share may, if desired be purchased at some time in the future - it's got nothing to do with the present day financial health of a company, and is a very hazy factor in the future potential value of a company's shares.
Expensing options is nothing but a big press deal - disclosure of options is all that is needed, and that is required to be done in publicly held companies already. A clear rule set of how they should be disclosed would be beneficial, but it seems no one is talking about that.
I would rather they didn't. It leads to short term business practices that damage the company in the long term. The executives responsible have already cashed out and moved to another company before the negative consequences start to show in the bottom line.
As an example, the corporation for which I work use to own a number of large facilities around the country. The land and buildings were owned outright so there were no loan payments to consider. A few years ago, all of the facilities were sold with the new owners granting a 20 year lease. This made the bottom line look really good that year. A few years later the rental expense is a significant impact that could have been avoided.
The executives who made that decision don't care. They made millions from it. Many of them took offers from other companies.
So, what's the solution? I don't know. I do know that executive stock programs have only made things worse.
The 5 year vesting often only applies to the lower ranks. Top level executives often receive options with either no or shorter vesting periods.
But lets put that aside for a bit. The real problem is that not expensing options is far too easy to abuse. Company grants options for 50 million shares. When options are exercised, company issues 50 million more shares. This doesn't impact the company bottom line at all. There is still no expense incurred. The only measurable effect is that earnings per share goes down. Then after several years of this, the company takes a one time charge to repurchase the stock they issued to cover the options.
That's not even taking into consideration the dilution of ownership caused by excessive option granting.