Employee Stock Options Must be Treated as Expenses

currivan writes "In a move that's been in consideration for a long time, the Financial Accounting Standards Board (FASB) approved new rules requiring employee stock options to be treated as expenses for reporting purposes. One of the reasons so many tech companies have given options to IT/engineering workers is that until now, they haven't counted against profits in quarterly reports. If markets were truly efficient, this wouldn't make a difference, but in reality, the tech industry is strongly opposed to the rule, though it should please Warren Buffett."

Comments

Hmmmm

[dfn5]

If the stock options you get are worth nothing, is that really an expense?

Re:Hmmmm

[Rude Turnip]

The problem is that some of them are worth something, and they're not getting expensed.

Re:Hmmmm

[Anonymous Coward]

An option has value whether it's currently worth something or not. There's a whole market in buying and selling options.

Re:Hmmmm

[HMA2000]

Yes. The opportunity is worth something all by itself. A stock option grant represents a potential dilution of ownership for current share holders. Think of it this way. Company A has 1 million shares of which you own 100K. You are entitled to a 10% share of the company's profits. The management of the company, in an effort to attract talent, grants 500K more shares. You're ownership now could fall as low as 6.67%. That potential dilution is a real expense to you. Even if it never comes to pass.

Re:Hmmmm

[danheskett]

Something only has value when it is bought or sold.

"Options" are just that - the promise of a future chance to make a sale or purchase.

Oher "options" that are provided for in business are not counted in the books: for example, if you sign a contract that allows you to buy a leased product at the end of the lease you do not have to count the eventual purchase price as an expense until (and only if) you exercise that option.

This is the kind of rule that people say is "common sense", but in fact, it's not very sensible.

Well, in my opinion that is.

Re:Hmmmm

[eXtro]

They should be expensed when they're exercised not when they're awarded because there's no guarantee that they ever will be exercised. So by taxing them before they are exercised you're creating work for accountants who'll have to keep track of them until their expiry date.

I've got a lot of options which I doubt will ever be exercised. The bulk of them were awarded when my company was trading at 14 dollars and change but now it's trading at near 2 bucks. They're expiring in 2 years and unless something miraculous happens they will not be exercised.

If something miraculous does happen then I will exercise them. Eventually they'll be sold and then taxed.

All this is going to do is ensure that non-executives don't get any options because of tax burdens. The twats at the top will still get them.

Re:Hmmmm

[danheskett]

That potential dilution is a real expense to you.
It is not a real expense. A real expense is something that actually costs you cash. Buying a new piece of equipment is a real expense.

This is a potential loss of value, that's what it is. In your example, that dilution of value for the owner still doesn't cost the company anything. The assets held by the company remain static. The value of the company remains static. The number of owners increases. That's all. There is no outlay of cash.

Stock options are both in effect and concept a gift among share holders. Options are promised at a price which is assumed to be less than the market price at a future point. You are promised the option to buy 10,000 shares at (usually) today's prices. When those options are available to you if the price is low enough you will exercise the options and the other stock holders effectively have given you the difference between market value and promised value: it's equity they used to have but is now transferred to the option holder.

Regardless, there is no expense to the company itself, only the individual stock holders.

Re:Hmmmm

[HMA2000]

So you are saying if you were in the situation I described you wouldn't take actions to protect your investment? You wouldn't seek alternative arragnements to maintain your equity?

Of course you would. Hence it is a real expense. If it wasn't a big deal it wouldn't be a big deal.

Re:Hmmmm

[Herbmaster]

If the stock options you get are worth nothing, is that really an expense?

Certainly. If a company give its employees worthless (underwater) stock options, they will likely find themselves in a bad position later on, when their employees realize they've been had. The company could be forced to buy back the stock options, reissue them at a lower strike price, exchange them for stock grants, or the lack of employees' confidence in the stock could simply force them to give out cheaper options or actual cash instead in the future. All of these represent a loss of value to the company. It shouldn't come as a surprise to investors because the company has been claiming the options it was giving out were "free" all along: the company should claim the expense up front when they issue the options.

Re:Hmmmm

[Anonymous Coward]

They should be expensed when they're exercised not when they're awarded because there's no guarantee that they ever will be exercised.

But the liability is created at the time they're issued. When they're exercised, the cash cost goes into the books for the amount that covered them, and the amount of the original liability is subtracted. In the accounting world you have to keep track of cash flow in addition to outstanding liability that may create an expense in the future.

Re:Hmmmm

[JPelorat]

I'm going to give you $10.

No wait, I'm only going to give you $6.

Have you, at this point in time and because of the above two lines, lost $4 in real cash?

No.

Re:Hmmmm

[Anonymous Coward]

Yes. Sort of...

He bought the stock, based on all assumptions he was going to gain $10.

Now because of your actions he only gains $6.

While he didn't pay out the $4 difference to you, he did lose $4.

Most of the time the biggest pinch is not the lost yield, but the lost value of the stock itself.

Thinking of money as what's in your wallet is not enough...

They're taking away his value, maybe that value wasn't money in his wallet, but it was his asset which is now not worth as much.

Of course, the same thing could be said by a reduction in the relative value of the dollar... you have a $10 bill... in 20 years although it's still a $10 bill, it won't buy what $10 used to buy, the market/government/iraqies/whatever have reduced the value of that dollar.

Re:Hmmmm

[caseydk]

If the stock options you get are worth nothing, is that really an expense?

Choosing numbers out of nowhere...

If a VC buys 5% of the company for $2M, then yes, the other stock would defnitely have some value as that puts an initial valuation on the company.

Of course that valuation can be wildly off...

Re:Hmmmm

[JPelorat]

No, he hasn't bought the stock yet. He has the option to buy the stock. That why they're called options.

Re:Hmmmm

[timster]

First of all options are transferable, in that you can sell them or buy them, so they have value in the first sense.

But besides that, in the case of your contract example, if the price at which you are allowed to buy the product is lower than the value of that product, then the contract itself has value.

If Apple "rewarded" its employees by issuing coupons allowing them to buy iPods for $50, those coupons would be valuable.

Re:Hmmmm

[nelsonal]

You have according to the rules of business, which require that you book $10 in revenue upon the promise to pay (and any associated costs or profits with the original $10 promise). The reduction would then be a writedown on the promise to pay. That is the heart of the difference between cash accounting and accrual accounting. If you sign a mortgage, have you not effectively given up spending $800/month for the next 30 years? Could you simply walk into the bank and expect to not pay them (without selling the house and paying off the mortgage)? Accounting says that your promise to pay should be reflected on the day you sign the mortgage rather than each month when the payment is due.

Re:Hmmmm

[TheWizardOfCheese]

There's no such thing as an option that's worth nothing. If you don't agree, then please write me some options for free.

Re:Hmmmm

[caseydk]

I'm going to give you $10.

No wait, I'm only going to give you $6.

Have you, at this point in time and because of the above two lines, lost $4 in real cash?

No.

This is why one political party always calls things "budget cuts" when they're actually "a smaller increase than requested".

Tell your wife that you're going to have an extra $10 and only bring home $6 and see what happens. ;)

Re:Hmmmm

[networkBoy]

Normal NQOptions are not transferable (at least none of mine are).

Furthermore, now that this rule is taking effect I will no longer receive stock options. That really sucks.
-nB

Re:Hmmmm

[JPelorat]

Well, that may be. I don't know. Business accounting has some weird shit going on.

But the cold reality is that he would be up $6, not down $4. Writedowns and promise to pay notwithstanding.

You can't lose what you haven't got. Except in business accounting, apparently.

Re:Hmmmm

[JPelorat]

Bingo

Re:Hmmmm

[networkBoy]

Look, options are a potential dillution of the stock, not an actual dillution. Tax them when excercized.
If you all insist on taxing them up front then don't you dare tax them when I excercize them because that'll be double taxation and I will do my damndest to not pay those taxes including a court battle.
It's all a moot point though, now that my employer will be taxed on these I won't get them any more. This is going to directly result in a less educated population because that money was going into my kids 529b plan.
I'm rather pissed about that.
-nB

Re:Hmmmm

[BridgeBum]

Disclaimer: I am not an accountant or an options trader. I do know plenty of both though. ;-)

Parent is right, here's another way to think about it:

Suppose 1 share of stock X is trading today at $10. I offer you an option to sell a share of stock at $20 anytime within the next 3 months, but I charge you $10 for that right. If you went out and bought 1 share of stock for $10 and sold it to me for $20, you get the $10 profit from the stock sale, but you had to pay me $10 for the option to sell ('put') that stock in the first place. Net profit zero, even though the option itself is worth something today.

Let's change it around a little bit. Now the stock is still selling at $50 today. Now I sell you the right to purchase ('call') a share at $55, also expiring in 3 months for $5. Currently, this seems like a bad deal: I'm charging you $5 for something which you could do better on your own in the open market. Let's say you buy 1 option at the $5 price plus 1 share of stock at $50. Two scenarios: Company X discovers a brand new Widget and the stock price soars up to $100. For the option, you spend $55 plus your original $5 and sell your new share at $100. Total profit: $40. Your share was purchased at $50 and sold for $100, total profit $50. So why would anyone want to buy options? You make less money, right?

Turn to scenario #2: Company X has a major scandal releasing Dihydrogenmonoxoide into the air in mass quantities, causing the stock price to fall to $10. Your option is worthless, so you throw it away. Total loss: $5. Your share of stock was purchased at $50, but now is only worth $10, total loss of $40.

The advantage of options is that there is less risk. The person selling the option must price it appropriately, or they will take on too much risk themselves. The price of an option is an attempt to try to guess what is the likelihood the option will be exercised, plus how much the price differential will be at the time it is exercised.

Re:Hmmmm

[AVee]

If the stock options you get are worth nothing, is that really an expense?

A stock option is worth as much as a lottery ticket. Nothing, until you win ;)
But (some) people pay real money for both, and if you can exchange something for real money it is worth something...

Re:Hmmmm

[networkBoy]

If I could transfer a stack of NQO's that I got at the top of the bubble I would. Then I wouldn't have as much red in my account. As it is in 10 years or so they'll age out anyway.
-nB

Re:Hmmmm

[johnnyb]

" Something only has value when it is bought or sold."

But your labor _was_ bought w/ options.

With the zero-value option theory, if a company wanted to show zero expenses, all they would have to do is pay for everything with options. Options are easy enough to value, especially compared to many other goods. There's not a perfect way to value them, but there's not a perfect way to value anything.

The fact is that the options were used as payment for services, and if they didn't receive options they would probably have requested some other kind of compensation, another clear indicator of value. If the employees didn't value the options, why go to the trouble of giving them?

Re:Hmmmm

[JPelorat]

"Sell", "Throw away" == actions that turned the potential loss into an actual loss.

Say you bought a share/option at whatever, $10. It trades one day for $100, and you think about selling it, but don't. The next day it's trading at $90. You sell it for $90. You could have gotten $100. Have you lost $10? No! You've gained $80!

I dunno. It's pretty clear we're all talking about at least two different things in this thread. I just don't see changes in potential gain/loss as actual gain/loss.

Re:Hmmmm

[Jerf]

Accounting isn't about "real cash" and hasn't been for a while. What you say is literally true, but in accounting terms, there was a real change to your assets, assuming of course that the $10 and $6 were commitments and not just some Slashdot guy saying something for a demonstration (because then the assets are $0 and $0, and no change of any kind takes place) :-)

I've had to learn some accounting to implement accounting systems, and the disconnection from real money is on the one hand powerful; it gives a better view of the functioning of the business than the bottom line "how much did we make or lose?" But it is, as usual with power, correspondingly more dangerous, if you start believing the numbers are too real; the phrase "bottom line" has entered our vernacular for a reason.

In double-entry bookkeeping, you change in promise would cause a debit for us (and the corresponding credit for you), causing a drop in our assets of $4. Our cash wouldn't budge an inch, but the accounting changes.

It's worth looking into (google "double-entry bookkeeping"); I find it similar in some ways to physics, in the way that it is sort of based on a "conservation of assets & liabilities" law. Treated properly it will improve your understanding of money. Misunderstood and it will make it worse.

Re:Hmmmm

[Luyseyal]

I think the real issue is this: Investors, potential and real, in Company A want to know what outstanding liens A has. Options are in effect a lien against the value of individual shares. The share price needs to reflect whether A pays all its employees $1 with 1,000,000 in options each per annum, whether A pays them all flat rates with no options, or A does something in between. The quick-n-dirty way to reflect this is to show the options as an expense which doesn't require changing how people evaluate the value of Company A and its stock. The "correct" way would probably be to list options as debt against the stock itself... something like:

Company A

Avg Share Price @ EOD 2004/11/15: $ 21.45
Avg Share Price @ EOD 2004/12/15: $ 23.45
Option Dilution per Share Nov-Dec: % 1.21

Estimated using 2004/12/15 price

Max Option Dilution per Share Q3: % 8.71
Max Option Dilution by EOY 2006: % 12.51

That way you warn investors of the dilution potential of the stock if all the employees decide to exercise their vested options at the same time within the next quarter and the next year. I see two problems with this: 1) accounting software will need to be changed and 2) talk about a scary thing to put in your prospectus! At least an expense can be nested in the details section.

What do you think?

Cheers and IANAA,
-l

Re:Hmmmm

[Bob Uhl]

Use the magical power of reading to see what he wrote: 'Regardless, there is no expense to the company itself, only the individual stock holders.'

Stock options are an expense to the stock holders, not the company. They affect the company's bottom line not a whit.

Re:Hmmmm

[johnnyb]

"It is not a real expense. A real expense is something that actually costs you cash."

Absolutely false. A real expense is something that when given prevents you from giving something else.

For example, you can't issue more options than you have stock to sell. Therefore, any option you give someone is an opportunity costs which prevents you from giving that stock to some other person.

In addition, granting a stock option prevents you from selling that stock as well. So, let's say that I give you an option on a $100 share of stock that lasts for 3 years. That means that I cannot sell that $100 worth of stock and stick the money in the bank. So, while I could be earning 3% on the money from the stock, instead it's tied up in an option. If I didn't want to sell it to begin with, I certainly wouldn't have given an option to someone, but giving an option prevents me from accruing interest on a sale.

The fact is that there are not infinite options. If I pay my employees partially in options, someday I might not be able to pay them with options. At that point I would have to find another equally-valued compensation method. The whole point of accounting is to know how much different parts of your business cost and make you. However, if you have zero-valued options, then the cost of your workforce is artificially low, and when you find that you can't give stock options any more, you will find out that the equations you used to govern your business no longer work because they never showed the true cost of your labor force. Likewise, investors will be fooled into thinking that your workforce is a lot cheaper than it really is.

Re:Hmmmm

[nightsweat]

And what's the value on an option that's underwater by five times the stock price and likely to stay there for the forseeable future?
'Cause that's what I got.

Re:Hmmmm

[EnderWiggnz]

there is no reason taht companies will not give out options now.

or, they will have to compensate you in another manner.

Re:Hmmmm

[killjoe]

Yes. This is exactly like when bill gates gives money to charities. He is not giving real money, he is transfering stock he got for nothing to his foundation which then sells the stock and gives the money to a charity.

It doesn't really cost him anything, just future (potential) profit.

Re:Hmmmm

[elmegil]

So make the companies report oustanding options in enough detail that potential investores know what effects they may have, and can figure them into whatever models of expense they prefer. Reporting them as an expense from the top, where you basically have to pull an arbitrary number out of your butt to figure out what the expense amounts to, is not the right solution.

Re:Hmmmm

[EnderWiggnz]

please take a god damn accounting course - please?

you're amazingly ignorant on this subject.

Re:Hmmmm

[networkBoy]

no, they will cease to give out options this is already known to all the non-exempt staff at my office.

Even the title blurb states that options were given out because they did not hit the books. Now they do. So they're gone.
These were considered a perk not compensation. We will not get anything else. Thanks FASB, you bunch of cocksucking asshats

-nB

Re:Hmmmm

[timster]

Sorry about that, I don't get options so I assumed they were similar to the ones that are traded on the open market.

However that does not change the fact that options have value at the time they are issued (unless it is a certainty that the stock price will go down).

I hope your company will compensate you in some other way. I hear Microsoft has switched to using stock grants instead.

Re:Hmmmm

[EnderWiggnz]

we arent taxing them when issued, we're taxing them when excersized.

we're talking about recording an Expense to the issuing entity.

there is no effect on taxation here.

Re:Hmmmm

[ethanms]

They were talking about when someone owns stock and options are given out...

So in this case the person who is losing value is the owner of stock... the person who is gaining is whoever is getting the option...

Re:Hmmmm

[Nopal]

You obviously haven't heard about accrual-based accounting. In accrual based accounting, an expense is incurred when the effort or service for which it belongs is expended, not when cash changes hands.

Under accrual-based accounting, options are always recorded at cost, so they always have value (par value or stated value plus or minus paid-in capital). Under accrual based-accounting, no buying or selling has to occur for it to be recorgnized and recorded. A mere "promise" satisfies the principle of materiality required to record the event.

In other words, it sounds as if stock options, which weren't liabilities in the past, should now be recorded as liabilities on the accounting period in which they are given. This is important because liabilities that represent expenses are significant to judging the state of the corporation even when they yet haven't actually been expensed yet.

Per FASB guidelines, all corporate accounting in the United States has to be accrual-based. The only entities that still use cash-based accounting are government entitites. With the new ruling, pretty much everyone but the government has to change the way in which stock options are recorded. So your point, though intuitive when thinking in cash terms, is largely inapplicable to everyone but the government.

Re:Hmmmm

[EnderWiggnz]

i think that you are looking at this wrong.

options are part of compensation, just like health insurance, 401k matching contributions, and free caffeine.

these are, absolutely, positively part of my compensation package, just as much as my bi-weekly check.

its an incentive plan, similar to at-risk compensation schedules where you can earn an ext $FOO% of your salary if you perform, or the company performs to certain guidelines.

generally, because of the risky nature (i.e. they could be worth zero) there is a higher reward if the options work out.

over the past 3 years, my options have been worth about 30% of my annual salary. yes, i sold.

if i no longer received comparable options, or got a commeserate base salary increase, i would immediately start looking for a new job, as my gross compensation package is reduced drastically.

Re:Hmmmm

[klreed42]

This is somewhat misleading.

When exercising the stock option, the exercise price is paid to the company, so the value being paid increases the Equity pool at the same time.
10% of 100m is the same as 6.67% of a larger pool. (This assumes that management can actually USE the extra equity to generate more return though).

The real value is the "time value" component of the option. The employee doesn't have to put money in now, so he doesn't have to risk his money unless the upside is realizable.
Stock goes down, he didn't buy.
Stock goes up, he can immediately buy low and sell high.

Re:Hmmmm

[Specter]

Companies already disclose the amount of options they're granting/have outstanding and the market is already taking that into account in the stock price.

These rules are ridiculous because they're ostensibly about making financial statements more clear when in reality they're doing exactly the opposite. No one knows what the value of an option will be until the time that it's excerised. Until then any valuation of the option is just a guess.

Re:Hmmmm

[Rude Turnip]

They still have value; they're just not worth as much as an otherwise identical, but freely tradeable, option.

Re:Hmmmm

[Moofie]

It's your responsibility to negotiate your compensation with your employer. If you're not satisfied with the current arrangement, change it.

Re:Hmmmm

[Nopal]

Of course it's real. What about dividends and other "perks" the company owner is now giving to the options (possibly voting, or preferred perks)?

Re:Hmmmm

[EnderWiggnz]

the stock holders are owners of the company, how can an expense to them, NOT be an expense to the company?

Re:Hmmmm

[xenocide2]

On the other hand, a submerged stock option is mostly useless to its owner. The potential dilution is a cost to the shareholders, but not the company itself. I think the Black-Scholes pricing system should reflect well enough on the books; if the stock option is submerged, then rational holders aren't going to exercise. Exercising them would both further destroy the revenue and book price to share ratio, and submerge any remaining options further. The black-scholes formula, on the other hand, will value an option at zero if submerged.

Before you say black-scholes is flawed, remember that it worked well enough for one company to make a trillion dollars or so in the market.

Re:Hmmmm

[Anonymous Coward]

My guess would be: $NotMuch

Re:Hmmmm

[UranusReallyHertz]

I consider myself to be fairly intelligent but I simply could not make sense of double-entry accounting. The whole damn field of accounting seems like its way more complicated than it really needs to be just to give accountants job security and better incomes.

Re:Hmmmm

[Moofie]

But if the options don't have any value, why don't you go obtain some and give them to me?

Re:Hmmmm

[Moofie]

"They affect the company's bottom line not a whit."

Except when they're used to compensate employees for services rendered. Then the options distort the picture of the company's expenses.

Re:Hmmmm

[Anonymous Custard]

No, they're a giveaway. The company could have sold the options/shares to investors, but instead they gave them away to employees.

Re:Hmmmm

[Yartrebo]

No taxation is going on. In fact, the corporation gets a tax deduction for issuing options. What this change is doing is forcing the company to report the same expense to the IRS as it reports to Wall Street.

Re:Hmmmm

[Anonymous Coward]

This is flat *wrong*. Options have value. Options give someone flexibility, and that flexibility comes with a price, whether they are exercised or not.

Re:Hmmmm

[Anonymous Coward]

UranusReallyHertz says: I consider myself to be fairly intelligent but I simply could not make sense of double-entry accounting.

just because you consider yourself to be intelligent does not make it true. however, it's probably just ignorance. take a course at the local college and i would hazard to guess it will all make sense to you.

the programming language haskell probably doesn't make sense to an accountant, but that doesn't make him stupid or the language any less useful.

Re:Hmmmm

[networkBoy]

negotiation of compensation is something that exempts may worry about, but for the non-exempts in high tech this does not happen. That is why in other industries non-exempt employees have collective barganing agreements otherwise known as Unions.
-nB

Re:Hmmmm

[Anonymous Coward]

I consider myself to be fairly intelligent but I simply could not make sense of double-entry accounting.

I consider myself fairly stupid and double-entry accounting makes a lot a sense to me. ;)

Re:Hmmmm

[Moofie]

You agreed to work for a certain compensation. That compensation has changed. It's up to YOU to renegotiate.

You may wish to proxy your responsibility to negotiate your compensation to a union, but it's still your responsibility.

I'm not saying "Tough luck", I'm saying "It's within your power to change this situation".

Re:Hmmmm

[JPelorat]

Hi, go fuck yourself, Merry Christmas.

Re:Hmmmm

[Anonymous Coward]

Sometimes, but not always. An option to purchase a leased product at the end of the lease can be handled several ways. If that option is a bargain purchase option (or several other rules which I don't want to bother listing) you must capitalize the lease. Therefore, the purchase would not be expensed.

Re:Hmmmm

[JPelorat]

I never said they dont have value - all I'm saying is that it's potential value, not real value. $4 does not physically come out of your wallet when the price drops.

Re:Hmmmm

[operagost]

Microsoft has been cooking their books this way for years. I remember reading a rundown by a financial analyst, somewhere on the internet, that if MS's employee stock options were actually counted as expenses MS would have had to post losses for several quarters.

Re:Hmmmm

[Moofie]

Go read up on the notion of depreciation, and then explain to me again what corporate accounting has to do with cash in pockets.

Re:Hmmmm

[Anonymous Coward]

Buying a new piece of equipment is a real expense.

Actually, no. Buying a piece of equipment is a capital expenditure - before you had cash, now you have the equipment, your net value is the same.

An expense is paying your electrical bill, rent, salary - you don't get any assets in return there.

Re:Hmmmm

[tekunokurato]

An option is never worth nothing as long as it is an option. Just because you won't necessarily get a payout doesn't mean it's worthless. In fact, just because you almost completely 100% sure WON'T get a payout STILL doesn't mean it's worth nothing. Just very little.

Re:Hmmmm

[Awful Truth]

If they were really worth nothing then your company should hand them out for free, on demand. I have a feeling they won't.

Re:Hmmmm

[Anonymous Coward]

I'm going to give you $10.

No wait, I'm only going to give you $6.

Have you, at this point in time and because of the above two lines, lost $4 in real cash?

No, I have.

Yes.

Re:Hmmmm

[Anonymous Coward]

sorry. those industries are being shipped overseas due to in part by the protection of lazy and incompetant workers by their unions. Want to accellerate the trend in high tech sectors? go start unions. The accountants have shut down the monopoly money printing presses that executives have used to pad their financial statements. boo-fucking-hoo. People wanted corporate hijinks eliminated after Enron, MCI, etc. This is one of the things that has to be done and needs to be done for all stock based compensation, not just options.

Re:Hmmmm

[hazem]

They should be expensed when they're exercised not when they're awarded because there's no guarantee that they ever will be exercised. So by taxing them before they are exercised you're creating work for accountants who'll have to keep track of them until their expiry date.

I don't know if you've heard about them, but there's this really nifty new invention called a computer. It's great for doing tedious things like keepking track of things in a database. You can store dates, values, expiration dates, and then generate reports. The really cool part is there is this whole network of computers called the internet where there is all kinds of information, like stock prices. The computer keeping track of the options can go out at any time and find the current value.

Of all the tasks an accountant has to deal with, this is not a big one. It's pretty straightforward to be able to keep track of them (lord, they should be anyway, right?), and have their values updated upon any particular report.

Sure, the value can change from report to report, but don't a lot of things, like the amount of depreciation on and salvage value of equipment?

I'm sorry your options are worthless. I always thought companies should give stock as an incentive, and not options.

Re:Hmmmm

[The_K4]

Actualy when issued they are usualyy worth 0. Since the price they are set at = the market value of the day. Also in MOST cases they vest over time so i can't sue them today even if the price of my stock doubles over night. So right now stock options are worth NOTHING the day they are granted.

Re:Hmmmm

[JPelorat]

Sheesh, fine, you win. Who'd have thought there were so many grouchy accountants around here...

But hey, at least you're not being a jerk like that other one.

Re:Hmmmm

[Woody77]

The major problem is that they have a value, but it's unknown. Which means that they essentially don't have a value.

Now, if the options are granted below the end-of-day market value for the stock on the date of the grant, then they have a value (the difference).

But if I get options for 1000 shares at $12.00, but they don't vest for 12 months to 48 months (standard), then what's their value at the time of grant? Nothing.

They are utterly worthless. For 12 months, they have no value. If I leave within twelve months, they have NO value, they didn't exist.

After 12 months, they have a *possible* value, which changes minute by minute during the hours that the market is open. Could be positive, could be negative. Nobody knows.

When I exercise them, they suddenly have a value. They are worth the market price. If I sell them that day, I get the difference between the market price and the option price. The company receives the option price as an investment by me into it.

If I exercise them but not sell them, usually a collossally bad idea, then I get no money. I have invested into the company, and received shares, but at option price instead of market price, and I have to worry about AMT on the difference.

*****

Stock options are great for a private company (because the FASB doesn't apply in the same way, since there's no market value).

For public companies, I don't think it makes sense. Because now part of your compensation is tied to the market, which is risky, because most of the market doesn't have a clue about what high tech companies do. It's amazing how many investors have NO IDEA what a company that they are investing in does.

The real danger of options is options to the executive staff. They are in a position to receive a lot of stock, and to easily manipulate the stock to their short-term advantage, and then run with the money (Enron). But that's something that can be worked with.

Calling the system flawed because it has a loop-hole that can be closed by itself is inane.

*****

Options fueled the Valley. People would work for peanuts (literraly), at a startup, because there was the promise that if the company got sold, they'd get money or shares in the new company, or if the company IPOd, the original founders would be rich as hell. If you're young, no family, the risk/reward ratio is awesome. Not for someone that has to worry about thier kids.

But even away from that extreme, I'd gladly take a hit in the paycheck for a shot at building a company up to be worth a LOT of money, if it was going to pay that back out to me in the form of investment in the company.

****

Flip-side. I think the market is broken. Seriously broken. It's ruled by short-term gains, which cause very bad business decisions to be made. Sure, the company could change things to be more profitable, but could the company sustain it's customer base at those levels of quality?

Re:Hmmmm

[Moofie]

I know only enough about accounting to know that it has very little to do with what happens in my checkbook.

You can win if you want. Anybody who's been watching politics in any country lately should be able to see you don't have to be correct in order to win.

Re:Hmmmm

[EnderWiggnz]

it does cost him something, as the shares that he is giving have value, and are fairly liquid.

just because something isnt cash, doesnt mean that it doesnt have value. a painting by Monet has value, as does a Louis XIV dining room table, houses/real-estate has value, heck even beanie babies have value.

just because there isnt a cash outlay, doesnt mean that it doesnt "cost" him anything even though it doesnt affect his cash position.

Re:Hmmmm

[EnderWiggnz]

and, believe it or not, before computers, people were able to do this with something called a "ledger", and a darn good filing system.

and funny red-filter hats for being able to see debits and credits.

Re:Hmmmm

[Opie812]

I see a problem even more basic than that.

Let's say Company A has revenue of 10 million dollars.
Let's say they have 1000 employees that in total make 10 million dollars.
For simplcity sake, that is the only "expense".

Let's say they pay these employees in stock options.
If they are required to show these as expenses, then their profit is zero. If they are not required to show them as expenses their profit is 10 million.

Stock options can very easily be used to cook the books. If you do it right, you can make a fledgling company look healthy.

That's what they are trying to prevent, in my opinion.

IANAA either; although, I do handle my family's cheque book....and it occasionally balances

Re:Hmmmm

[timster]

If they are truly worth nothing at all when issued, that would mean that it would not matter to you whether you had them or not. If they have no value, then you throw them in the trash can with your other worthless papers.

They have value -- it may be speculative value, but it is still worth something. Let's say I have a ticket that will pay $100,000 if a specific die roll on January 1st, 2005 comes up as a 3. That doesn't have a value of zero just because you can't use it right away. Would you pay $100 for such a ticket? $1000?

Re:Hmmmm

[homerules]

Yes, making sure that businesses do proper accounting to reflect their economic soundness so that investors can make better informed decisions is a horrble, horrible thing.

Re:Hmmmm

[Bob Uhl]

The same way that the amount I spend on food isn't an expense to any company I own stock in.

Re:Hmmmm

[Anonymous Coward]

The real reason it doesn't "cost" Gates much is that his foundation is a charitable foundation allowing him to subtract the value on his taxes. So instead of selling his shares to get cash, he can give some of them away and pay less taxes instead. It's better than selling all of them on the open market and affecting the share price negatively.

Re:Hmmmm

[jdi]

All of this option information is already publicly available for every company. It is published in the notes appended to every corporate financial report. Good analysts already make the appropriate adjustments to Income Statements based on options expenses, and alter their valuations accordingly. This FASB rule just makes reading financial reports a little easier for the layperson.

Re:Hmmmm

[DroppedPacket]

No, I think you are looking at this wrong. Options are Potential Energy sources. When they are issued they have 0 value to you because they 1) can't be traded (vesting time) and 2) are issued with a stock price set at the current stock price.

Now the price to the company is variable and impossible to determine. Why? When you exercise your options, the company takes some of the actual stock you hold and sells it to you for the strike price of your option. Until that event happens, the price the company paid for the stock is unknown. The stock could never have been issued ($0 cost) or it could have been re-purchased from the market (price could have been below your strike price or even above your strike price.)

The act of exercising your options converts the Potential Energy into Kinetic Energy. Now you can determine 1) How much the stock cost the company and 2) How much you have earned by selling that stock on the open market (if you chose to do so.)

If you expense an option when granted, what happens to that expense when the option expires worthless or the employee is no longer with the company (and the option isn't exercised)?

Does the company record that as income? For firing an employee?

Re:Hmmmm

[killjoe]

It depends on how you define cost.

Was he going to sell those shares anyway? Probably not. Was he going to sell them today? probably not.

Chances are he was going to leave those shares to his kids. He wasn't ever going to sell them. He is giving money that in all likely hood would have ended up in his kids hands.

Also as I said it did not "cost" him anything. It's not the same as you and me giving a few hundred dollars to the food bank. That would be a sacrifice for us. For him there is no sacrifice involved.

Re:Hmmmm

[Miguelito]

But besides that, in the case of your contract example, if the price at which you are allowed to buy the product is lower than the value of that product, then the contract itself has value.

Personally I think this new rule sucks, and it's going to nix options for a lot of people (and yes, probably me).

Here's an example of why this is stupid:
- I'm granted options today, company will be charged today. I can't touch them for some time (there's usually a vesting schedule). By the time I'm vested, the value has dropped, so to me, the options are worthless (why would I buy at a higher rate when I can buy at the market rate if I really want shares?). The time limit of the options passes, and I never exercised them (or I left the company and forfeited them, etc).. the company had to show a charge for something that was never used. Therefore the company's bottom line took a hit for absolutely nothing. Does that make sense?

What I think the rule should be, if they insist on options not being "free" as far as the company goes.. is that the options should be listed if and when they're actually optioned. Whether it should be for the difference, or just the option price.. I don't know.

And as another mentioned... no Non-Qual options that I know of are transferrable.

Re:Hmmmm

[Anonymous Coward]

No, absolutely true. At least the parent holder seems to have taken an accounting class once upon a time.

Re:Hmmmm

[Anonymous Coward]

lol... flamebait... wheee...

Re:Hmmmm

[Anonymous Coward]

There are a lot of expenses which don't cost cash. Inventory depreciation, bad debt, depreciation of goodwill, etc.

Re:Hmmmm

[bar-agent]

Are stock options to be recorded as "liabilities" or as "expenses"? In my limited understanding of double-entry bookkeeping and accrual accounting, there is a difference between the two.

You mention "liability", but the article says "expense".

Re:Hmmmm

[John Hurliman]

I believe the parent poster meant liability in the sense of the Assets = Liabilities + Owners Equity equation, whereas before this ruling the stock options didn't exist in the (public) financial records until the options were exercised, essentially doing cash based accounting in an accrual based report.

Re:Hmmmm

[jeif1k]

With the new ruling, pretty much everyone but the government has to change the way in which stock options are recorded.

The government gives out stock options??? :-)

Re:Hmmmm

[Anonymous Coward]

That person is most likely Bill Parish.

He doesn't just say that they'd post losses, but he goes further saying it's a "financial pyramid" and that it's going to collapse. It's important to note that this was in '99. I think we can all recognize that what Bill was seeing was not infact Microsoft building up but the .com's building up. Microsoft doubled during the boom times, but it wasn't anything compared to what the .com's were doing.

Anyway, we can see that Microsoft hasn't caused the collapse of the financial market's, they've dropped stock options and are now expensing stack grants, and yet the bottom hasn't fallen out. Personally I think Bill Parish is full of shit. And that is re-enforced by the fact that he hasn't seemed to comment on his previous doom and gloom predictions.

Re:Hmmmm

[jbolden]

Because until the last few decades accounting rules were based on the bond holder's interests not the stock holder's. Things that hurt the owners but did not reduce the company's ability to pay debts didn't matter.

Re:Hmmmm

[Luyseyal]

Frankly, I don't know that much about financial statements -- I was just trying to cover The Obvious[tm]. It was my understanding, though, that options were not well stated in their current form, making it more difficult for an investor to tabulate their potential effect on a stock than it should be.

-l

Re:Hmmmm

[The_K4]

Actually value and potential value are two vastly different things. When you by a house do you report what it might be worth in 10 years on your value for property taxes? Why you buy a car do you pay what it might be worth if 25 years if it becomes a rare classic auto? Your "lucky" ticket's value is that which you paid for it, until that roll happens, personally I wouldn't pay you a dime for it because it could just as easily be worthless. That's why I don't play the lotto. However since that ticket MIGHT be worth X millions of dollars you must be willing to pay a lot for it.

How will it work?

[gtrubetskoy]

Can someone confirm how this really works? When options are granted, it is usually an option to buy a certain number of shares at today's market value. So on the day of the grant, the value is usually always 0.

Let's say an option is granted to buy N shares and a year from the date of the grant, the stock is up by 10 points - then the value is then 10 x N. So the company now needs to subtract 10 x N from its earnings for the fiscal year during which the stock was up by 10 points? Then next year it goes up again and the company adjusts earnings again? Ad infinitum?

OR does the company just make a speculation, something like "we think the stock will go up by 10 points this year, so lets just subtract 10 x N from earnings". But what about the value 10 years from now?

What happens with taxes? It is advantageous for a company not to ever show any profits, this seems like a simple way to reduce your taxable income as far as the IRS is concerned. Most corporations don't pay any taxes anyway, but now this just got easier: "Let's grant everyone a bunch of options that we deem are worth 10 bazillion"?

Lastly, I don't see how this rule will affect anything at all since more likely than not companies will just be publishing two numbers - earnings with stock option adjustment and without. Kinda like EBDTA.

Re:How will it work?

[Anonymous Coward]

Most likely they'll use an outside investment company to give them an estimate of what the options would sell for on the open market. That's a common method used by companies that have already been doing this.

Re:How will it work?

[MyLongNickName]

No, it is NOT a zero value. Take a look at your Wall Street Journal. People buy and sell options all the time. It is an educated guess about the direction of the company.

Often used to offset the risk of other investments (i.e. I buy Company A stock, but I want to protect against a big drop, so I buy the right to sell the stock at a certain, lower price). This helps you to get to a target risk level and still have a wide variety of stock to pick from.

Often, this is used by pure speculators too :)

For a large company, there is sufficient market information to make a good estimation of the value of a certain option. What is unclear, however, is how you do this for a small company without enough market activity to have an options market. or worse yet, a private company who's value is determined by a third party's valuation.

However, market valuations would take care of the vast majority of the bad accounting deals you ahve heard about on the news...

Re:How will it work?

[Rude Turnip]

"When options are granted, it is usually an option to buy a certain number of shares at today's market value."

Yay...I get to show off my knowledge of finance on /.! When options are granted, you are getting an option to buy a certain number of shares before a certain expiration date. The option to buy shares is a "call" option.

The "exercise" or "strike" price is the price at which you may buy the stock. It could be below current prices, in which case you'd make an immediate profit. When the strike price is below the current stock price, the option is considered "in the money." When the strike price is above the current market price, you can't make a profit right away and the option would be considered "out of the money." However, just because an option is out of the money doesn't mean it's worthless. Between the growth in the value of the company and the volatility of the stock price, there is still a possibility that it could be in the money before expiration.

Re:How will it work?

[rmcd]

Companies will use standard option pricing techniques, such as the Black-Scholes formula or binomial option pricing. You can read about them here.

You are incorrect in saying that the value of the option at grant is zero. If I flip a coin and you get $1 if heads and 0 if tails, that is worth something to you. An option is the same: you get a payoff if the stock goes up and nothing if the stock goes down. The valuation problem for standard options (like those traded on the CBOE) is well understood. There are tricky issues in applying option pricing to employee options, but their value is emphatically not zero.

Re:How will it work?

[Otter]

No, it is NOT a zero value. Take a look at your Wall Street Journal. People buy and sell options all the time. It is an educated guess about the direction of the company.

If I recall correctly, the old voluntary guideline from FASB was that the value of the options was calculated according to Black-Scholes and a resulting expense is declared. As you say, it's unclear how well that will work for small companies with no history of stock volatility.

Re:How will it work?

[twiddlingbits]

Options DO have value to the FIRM, they will be expensed at the Market closing price of the stock on the day issued. If the company had sold that stock to Joe Public, they would have recorded the revenue, giving it to Joe Employee means they gave away something with value thus an Expense in Accounting terms. Joe Employees doesn't record any loss/gain until the options vest and are exercised. I'll have to read the rules but i hope FASB will let the companies expense the options as they vest not at the time they are given, and if the options never vest they are never expensed.

However, what the FASB rules say and what the IRS rule say can be different. I don't think the IRS has ruled on this area yet, they were seeing if FASB could work it out and maybe jump on that. And yes, companies DO pay taxes, but it's at a fixed rate. They however get lots of tax deductions you and I can't get.

I suspect you will start seeing some funky statements in earnings reports like you mention. I think the Stock Analysts will ignore it, as Earnings are only 1 component of what they measure to "estimate" the stock price. Cash Flow (which options do not affect) is a better measure of how strong a company is for the future.

By the way, I don't think the rank and file techie options are driving this FASB statement, it's more the massive options given to the techie (and other) EXECUTIVES that they are concerned with.

Re:How will it work?

[mordors9]

There are few details and alot of it makes little sense. They are being forced to expense something that does not effect revenues or profits. The company is diluting ownership in the company by issuing additional stock. But the total value of the company remains the same. Granted it has been a few years since I studied this in college, but I am a bit confused. My company does not even allow any of the option to be excercised for a certain number of years and then it is on a sliding scale percentage wise. How are you going to expense that? Is it expensed in the year of issue even though none of it is excercisable. Is it expensed in the year it is excercised?

Re:How will it work?

[rmcd]

Think about it this way: companies that *don't* use options as compensation will report lower profits because they will pay more cash to their employees. What the rule does is make reported income comparable between companies that do and don't use options.

Also, while you're right that the value of the company is the same, the distribution of that value is changed: existing shareholders get a smaller piece of the pie when the company grants options to employees.

Re:How will it work?

[Anonymous Coward]

Options DO have value to the FIRM, they will be expensed at the Market closing price of the stock on the day issued.

No they won't. They would be expensed at the market price of the option, if such a thing existed, which it typically does not. Realistically, the expense will be determined by an options pricing model.

Also, FASB has nothing to do with the IRS. This issue pertains to revenue for the purpose of stock analysis, not for taxation. If it had the potential to lower taxes companies would have been pleading for it.

Re:How will it work?

[twiddlingbits]

FASB hasn't determined the guidelines for pricing the options, so who knows if they will stick to Black-Shcoles or go with some other valuation of thier own. Around 40% of the companies that issue options to employees already expense them. Also, the companies I worked for that granted options disallowed you to sell the options on the Options Market (after you vest). So, there really isn't access to a Market so Market price is kind of an academic exercise. You must buy and resell the stock to make your money.

Re:How will it work?

[nelsonal]

The intrinsic value is currently 0, but the value of the right to buy stock at the current price is non-zero. The simplest model is binominal. Say you have a $10 stock with a 60% chance of rising 10% in each of two years, and a 40% chance of falling 10% in each year. So there is a 36% chance of the stock finishing at $12.10, a 48% chance of finishing at 9.9 and a 16% chance of the stock ending at $8. Your call is valuable at the end of two years if it finishes in the money. So there is a 36% chance that your call option will be worth $2.1 and a 54% chance it will be worth nothing, two years from now. This totals about $0.75 (which would be discounted back to the present at the risk free interest rate). Using a risk free rate of 5% givees a call premium of $0.68. Even though the current intrinsic value is $0 (right to buy $10 stock at $10 for the next two years).
Of course, this is a very simplistic model (two end states, and two years). The most common model (Black-Scholes) is the limit of the binomial model as time approaches 0. You can google around for black-scholes and see the model.
The IRS rules are very accurate, but do not square with the guiding principle of GAAP (try to keep costs and revenues in the most appropriate period). The IRS waits until an option is excercised and then counts the cost as the difference between strike and excercise price. So the IRS is not taxing companies based on options that were issued in the past, GAAP tries to keep options expense on options issued in the present, which is why the model must use uncertainty.
Finally, I fully agree that most companies that issue any signficant number of options will be issuing numbers with and without options expense (and guess which numbers analysts (and therefor investors) will be following. The other change that is likely to occur is a shift toward fewer numbers of share grants. Since most employees don't correctly value options (they also assume option value=intrinsic value) companies can greatly reduce dilution by granting employees shares that are equal in value to the options they would have granted. Say you were granting $10,000 in options that might have been for 1,000 shares, now companies will be more likely to grant 50 shares of stock (worth the same $10,000), but to the company the stock has considerably less dilution associated with it. The end of the accounting trickery (options have zero income statement effect, but stock grants have considerable effect) will bring about this change.

Re:How will it work?

[twiddlingbits]

Say you were granting $10,000 in options that might have been for 1,000 shares, now companies will be more likely to grant 50 shares of stock (worth the same $10,000), but to the company the stock has considerably less dilution associated with it. The end of the accounting trickery (options have zero income statement effect, but stock grants have considerable effect) will bring about this change.....

I don't see companies moving to Grants. Options were used as a management motivation tool to encourage employees to help make the company more profitable via thier labors. If that happend the stock options came above water and the vested shares could be sold at a profit. Giving grants is more like an immediate reward, and it really DOES have costs in the period issued. I suppose they could restrict the sale of Granted Stock but the stock still belongs to the employee and they are now officially stockholders not stockholders to be as with options. Bottom line, I don't think we'll see more grants, but we will see less options and a move back to traditional cash compensation. That's NOT a bad thing IMHO.

Re:How will it work?

[Otter]

Ah, the new policy is in the FAQ:

The Statement specifies that the fair value of an employee share option be based on an observable market price of an option with the same or similar terms and conditions if one is available. In the United States, equity instruments identical to employee share options are currently not traded (but may be in the future); hence, there are no observable market prices. The Statement requires that the fair value of those instruments be estimated using a valuation technique that (1) is applied in a manner consistent with the fair value measurement objective and the other requirements of the Statement, (2) is based on established principles of financial economic theory and generally applied in that field, and (3) reflects all substantive characteristics of the instrument (except for those explicitly excluded by the Statement, such as vesting conditions and reload features). The affect of vesting conditions are taken into account by requiring that compensation cost be recognized only for share options or restricted shares the entity expects to vest and that actually do vest. Additional information regarding estimating the fair value of an employee share option can be found in Appendix A of the Statement.

I'm not sure if "The affect of vesting conditions are taken into account..." is technical jargon or if CmdrTaco is moonlighting at FASB...

Re:How will it work?

[Anonymous Coward]

Say you were granting $10,000 in options

What does that mean? Options are not money, there is no such thing as "$10,000 in options" on the day of the grant.

Re:How will it work?

[gtrubetskoy]

I'm not sure if "The affect of vesting conditions are taken into account..." is technical jargon or if CmdrTaco is moonlighting at FASB...

ROTFL

Mod paren up, this is 5 Funny!

Re:How will it work?

[gtrubetskoy]

When options are granted, you are getting an option to buy a certain number of shares before a certain expiration date. The option to buy shares is a "call" option.

You're talking options as the ones traded on the Chicago Borad Options Exchange. Employee stock options are a different beast - unlike market options, they are not transferable and (for the most part) never expire. They are also not clearly defined, because they sometimes void if your employment is terminated, but sometimes they have "triggers" in them whereby they automatically vest upon employment termination unless your employment is terminated "for cause" (i.e. you got fired for doing something bad). The options with triggers are subjectively more valuable, but how (and why?!) you'd want this reflected on the books escapes me completely.

Re:How will it work?

[twiddlingbits]

Yes, thats the POLICY..I said the pricing MODEL which must conform to the policy. It looks like Appendix A might be the place where the pricing Models are at. Also, if there are multiple "acceptable" models, then can I use the one that gives the lowest price? I see LOTS of wiggle room in the statments in the FAQ. I'm sure those gaps will be closed over time :( Or better yet, Congress overrules the whole darn thing!

Re:How will it work?

[Anonymous Coward]

There's a famous formula called the Black-Scoles formula, or variations of this formula, that's being used to value the value of stocks. It works as roughly as follows:
(1)The basic premise is that if the stock is risk free and no dividends are paid out then the stock should appreciate the same way a bond would.
(2) secondly you adjust for risk. The more risky a stock is the more the option is worth. The reason is that the down side risk is limited(the options minimum value is zero) while the up side is theoretically unlimited.
(3) you adjust for expected dividends.

And yes, this is a huge improvement seen from the (fiancial) market's view point. I'm a economics student(I have studied and written reports on a few companies) and let me tell you: Correcting for stock option is often the most annoying aspect lack of disclosure makes valuation very difficult. This is a Good Thing, especialy for small investors that lack the intricate knowledge that is required to unravel the often very complicated options schemes

Re:How will it work?

[krbvroc1]

Lastly, I don't see how this rule will affect anything at all since more likely than not companies will just be publishing two numbers - earnings with stock option adjustment and without. Kinda like EBDTA.

That may be true, but that is a good thing.

1) Investors should be able to look at the financial details and see how much liability there is. As an investor, you may want use stock options as a metric about how a company is run.
2) Stocks options are not 'free money'. When a company gives them away, they create a liability to the shareholds and dilute the value of a company. Just like the US Federal Gov't uses financial trickery to move certain expenses 'off budget', options hide the true financial health of a company.
3) Financial reports represent a snapshot in time. Why shouldn't the expense of options be declared in that snapshot.
4) Options are given out too easily because they don't show up on the bottom line.
5) This is truly common sense because you should always err on the side of full disclosure.
6) Most experts agree that this makes sense, they've agreed for a long long time (pre dot com days). The lobby against it has been from people who are more interested in their personal pocket books than the overall health of the financial system.

Re:How will it work?

[nelsonal]

Excactly what the company is trying to avoid. Say you are given a contract to buy 1,000 shares of the company stock at the current price at anytime during the next ten years. That contract transfers a signficant amount of value to you (probably something like $10,000-although ) even though it grants you options that are at the money. Employees generally don't assign any value to that option contract even though it has real costs. This was fine when companies could justify to the SEC that options were not real costs, but now not so much.

Re:How will it work?

[EnderWiggnz]

>The options with triggers are subjectively more
>valuable, but how (and why?!) you'd want this
>reflected on the books escapes me completely.

because they have a material dilutive affect on shares outstanding, and therefor affect per-share earnings.

if i owned 10% of the company, but there were enough options outstanding that if all excersize that it would reduce my ownership stake to 8%, this has a material affect. it should be accounted for.

Re:How will it work?

[Rude Turnip]

"Employee stock options are a different beast - unlike market options, they are not transferable and (for the most part) never expire."

I have to prepare appraisals of employee stock options now and then. I won't get into the details of how we deal with the non-transferability, but every one I've run into so far has had an expiration date. You can use the traditional Black-Scholes model to value them as if they were freely traded options, but then you need to use some business valuation voodoo (that I do) to adjust for transfer restrictions, vesting, etc.

Re:How will it work?

[blair1q]

Every option I was ever granted started out with a couple of dollars of value (even when they're "out of the money" you have to pay cash for a call option on the open market). As the stock appreciated, naturally, the value of my options increased, but I couldn't exercise them until the end of the vesting period (3-5 years for most corporations).

It's an interesting question, "what's the value of something you are barred from reselling", but not really, because the bar could just as easily be my own reticence to sell. And I could have written naked LEAP calls on the open market at any time.

So an option is an option is an option, and all options have some market value, no matter how ludicrous the deficit between strike price and stock price.

Re:How will it work?

[Anonymous Coward]

Every option grant I've ever received had an expiration date.

Re:How will it work?

[revscat]

6) Most experts agree that this makes sense, they've agreed for a long long time (pre dot com days). The lobby against it has been from people who are more interested in their personal pocket books than the overall health of the financial system.

One more party is worth mentioning: free market fundamentalists. There are those who put this in the "regulation bad" bucket and discard it immediately as "increased bureaucracy". They wouldn't be worth worrying about except for the minor fact that they control the national fiscal agenda right now.

Re:How will it work?

[gtrubetskoy]

When a company gives [stock options] away, they create a liability to the shareholds and dilute the value of a company.

This seems like the crux of the matter. When a company grants stock options, shouldn't it at that time make sure that it owns a sufficient number of shares so that the option may be honored? Or in other words, are options granted in consideration of issued (and company owned) shares (1), or is it usually the plan to issue them later as needed (therefore diluting share value) (2)?

But in either case I still don't get how this affects earnings. In the scenario (2) it seems to affect future value of a share, and in (1) seems to lock out any appreciation of the shares that a company owns (the shares against which options are granted will never grow in value ).... Anyway, I'm glad I'm not an accountant.

Re:How will it work?

[HidingMyName]

No they won't. They would be expensed at the market price of the option, if such a thing existed, which it typically does not.

Your assertion about the value being correlated to the options value is correct.

However, options actually options do have a price as they are traded publicly. As they approach the time that they are exercised, if they are options to buy (calls) and the strike price is below the stocks market value, the options value tends to converge to the (market price - strike price). For sell options, (puts) the price tends to be (strike price - market price) where in this case strike price corresponds to the price the owner is allowed to sell the shares at. Calls with strike price greater than market price and puts with strike price less than market price would have negative value if they were exercised. I am not sure, but I think puts may be riskier, since it may obligate you to trade the stock at a particular price on a given date (they may sell matching puts and calls) so our risk is bounded only by how much the stock's price increases.

However, since options are usually granted well before when they are exercised, their value is more volatile (and sometimes depressed). However, if the company is publicly traded and options exist on the market, then the market may provide an indicator of the options value.

Re:How will it work?

[DarkOx]

It won't have any impact on taxation. There are GAAP rules for accounting, which you use for all financial reporting to share holders and investors. Then there are tax rules, which you use to calculate your taxes. Most public companies keep two sets of books. One according to tax rules and one GAAP.

Re:How will it work?

[krbvroc1]

This seems like the crux of the matter. When a company grants stock options, shouldn't it at that time make sure that it owns a sufficient number of shares so that the option may be honored? Or in other words, are options granted in consideration of issued (and company owned) shares (1), or is it usually the plan to issue them later as needed (therefore diluting share value) (2)?

My understanding of the issue is as follows. First, a company 'registers' shares. A register of shares is not the same as issue of shares. Issuing shared typically go through an IPO (or secondary IPO) process. Second, like the US Treasury, a Corporation can print its own money. It can 'create' more shares. However, just like the Treasury, if you double the amount of shares outstanding, you half the value of those shares already present. Company do this all the time with 'stock splits'.

How does this affect earning? I think this is where it gets tricky. Financial statements dont fully reflect reality - they contain assumptions and estimations. And they are only a snapshot at a single point in time (end of quarter/year). Companies expense all sorts of things - such as 'Goodwill', 'Intangibles', 'Depreciation'. Also, when a financial statement is created, the current 'exchange rate' of international currencies are factored in, even though it isn't a real cost.

I think whole problem here is that companies want to use stock options as 'free money' to attract 'talent'/'management' without the accountability. Its very much like the US Fed Gov't borrowing from the Social Security fund. Its really easy to drop an 'I-Owe-You' note in there and worry about it later

If you compare two companies - one who hires a person and pays them a fixed salary and one who hires a person for a lesser salary but gives them an option to by $50 worth of stock for $10 - shouldn't there be a financial statistics/measure to differentiate the practices of the two companies?

Finally, many times rules come about because of abuse. Stock options have been abused by companies to give exhorbitant bonuses to executives. This gives executives incentive to drive up the stockprice in the shortterm, so that the options can execute before expiration, but not the incentive to build a stronger, longer lasting, sustainable growth policy.

Re:How will it work?

[Anonymous Coward]

Doesn't the company already own the units they are offering as an option to their employees?

Re:How will it work?

[Anonymous Coward]

shares in treasury are not taken into account when calculating EPS, and other per-share numbers.

so - they dont count.

Re:How will it work?

[krbvroc1]

What happens with taxes? It is advantageous for a company not to ever show any profits, this seems like a simple way to reduce your taxable income as far as the IRS is concerned. Most corporations don't pay any taxes anyway, but now this just got easier: "Let's grant everyone a bunch of options that we deem are worth 10 bazillion"?

And herein lies the rub -- the FASB regulations guide the standards by which accountants produce financial reports. The tax regulations are a separate system. For years, these same tech companies who are arguing against expensing stock options on their financial disclosures, have been expensing stock options and reducing tax liability on their IRS filings; in some cases paying no taxes at all.

Enron avoided billions of dollars in taxes by expensing their options on their IRS filings. However, when it came to the financial statements that are used by the investors/shareholders (those quartly/annual reports you get sent), they hid these values.

Re:How will it work?

[Shalda]

The problem really is that accountants and accounting in general are retarded. A stock option is basically a liability. When exercised, it then becomes an expense. It should be trivial for a company to put 2 lines on the quarterly report: Value of outstanding stock options and cost of recently exercised options. They could even put together a couple of little charts showing the distribution of outstanding option values. But that might actually be informative and make sense, so it'll never happen. This is why I invest my money in things like pizza.

Re:How will it work?

[Keeper]

This isn't so much about the value of the options as it is the cost to the company.

It costs the company $0 when they issue the option, and some amout >0 when the option is exercised.

If the company gave out a million options this year, it didn't cost them anything. However, if they report it cost $2 million, and 3 years later when the options are excercised it actually cost them $30 million, the reporting didn't do a damn bit of good.

What they ought to do is show the number of outstanding options and the Potential cost to the company at various price points, so you can get an idea of a companies obligation and the potential impact of the options. They should also expense options when they are excercised, as they cost the company money at that point in time.

Re:How will it work?

[Anonymous Coward]

Really? All zero of them? Fascinating!

Re:How will it work?

[truesaer]

Its not too difficult. It goes like this...on the date the options are granted, the company takes an expense if the amount of the option is under the current share price. So if you are granted an option to buy at $18 and the stock is at $20, that is a $2 expense. In practice options are almost always issued at the current stock price and this expense doesn't occur.

Then, you record an expense during the vesting period equal to the amount of the option's value according to the black-sholes model. So if your option has a market value of $5 and vests over 2 years and the company reports earning 4 times per year you will take an expense of 5/8=$0.625 per reporting period.

And thats it.

Tax Implications?

[TrollBridge]

IANAA (accountant) but I would think this move might have some massive tax implications. Would this force companies to pay more in payroll taxes? Could it allow them to pay less?

Someone with more knowledge on this please reply. thanks!

Re:Tax Implications?

[grub]

Along the same lines I was wondering if the employee would have to file them as a taxable benefit/income.

Re:Tax Implications?

[TrollBridge]

I'm pretty sure that income from stocks, be they employee options or simply purchased, are taxed as income AFTER they are sold. But again, IANAA.

They can't be taxed until the sale because their value is in constant flux.

Re:Tax Implications?

[Bimo_Dude]

Would this force companies to pay more in payroll taxes?

I sincerely hope not, since payroll taxes are those that are deducted from the worker's pay. If they did that, then the workers would be paying the taxes, not the corporations.

Re:Tax Implications?

[CountBrass]

There are three kinds of stock related benefit:

The first is where the company outright gives you some stock. In the UK this counts as a benefit in kind and is taxed as income.

The second is a share purchase scheme. How this is treated depends on whether or not it's approved. Let's assume not (as all the ones I've been haven't been): then it the value of the purchase when you first "buy" the shares is taxed as a benefit in kind, again income, for example a typical scheme gives you a 15% discount you pay that tax on that benefit. Then when you sell the shares any gain is treated as capital gain (which has a separate allowance from your income tax) and anything above that allowance (7000 GPB for all capital gains) is taxed as un-earned income at 40%. The major difference with an approved scheme is that you must hold the shares for a minimum period and you only pay 10% capital gains.

The third is share options and, assuming they're priced at the current market rate, then you pay tax on them as a capital gain (see above). YMMV, IANAA and this is only the UK based on my participation in such schemes. And regardless of how they do any kind of share scheme is an expense as at the very least it dilutes the existing shares. Edward

Re:Tax Implications?

[Anonymous Coward]

Perhaps, I'm really not sure. Of course I'm taking the Canadian perspective where we get taxed before, during and after. :)

Re:Tax Implications?

[sg3000]

> I'm pretty sure that income from stocks, be they employee
> options or simply purchased, are taxed as income AFTER they
> are sold.

I'm not an accountant either.

My understanding is that options are not taxed when they are granted. However, once they're exercised, they can be taxed in two ways:

1. If the option is exercised and the resulting shares are sold, either immediately or a year later, then the resulting income is subject to capital gains tax (either at the short term or long-term rate, depending on when they were sold).

2. If the option is exercised, but the resulting shares are not sold, then the person is possibly subject to the Alternative Minimum Tax (AMT) on the amount the shares are worth at a certain period of time. I believe the any AMT paid is can be applied towards long-term capital gains tax (if due later on), or it can be refunded in some cases.

The AMT killed a lot of people during the dot-com boom. People would be granted options at say $1 per share. Then the company would declare an initial public offering (IPO), and maybe the shares were sold at $10 per share. Then the shares climbed to $20 per share. You may have to pay AMT at $20 per share if you held the stocks. However, if you sold the shares for $15 (you held too long), then you would get to apply the overpaid AMT in the year you sold.

However, for many people, the amount they had to pay in AMT was tens of thousands of dollars (or more, in one case I knew of), and it was completely unexpected. The problem came from the fact that AMT is set to an absolute number, and has not been scaled to match inflation.

Re:Tax Implications?

[Rombuu]

IAAA (I am an accountant), and essentially you keep two sets of books, one for accounting purposes and one for tax purposes. Tax accounting is based on cash flows in and out of the company. Since this rule change doesn't effect these cash flows, there shouldn't be any tax implications to this change.

Re:Tax Implications?

[Jonny Royale]

From the FAQ from the FASB:

Q: Does the statement change US TAX Law?

A: No. US Tax Law is established by the US Government. This statement has no impact on either federal or state tax law.

Basically, the tax you calculate and pay is based on tax laws, wich are different than FASB standards. The tax liability is brought back into the balance sheet, but it's calculated spearately, for tax purpouses.

Re:Tax Implications?

[Anonymous Coward]

Yes it has. It was always there.

Take this example, A MS employee exercised his option for a profit. The employee will pay tax for that profit.

The funny part starts after the the employee pays the tax! Who give the benefit to the employee that trigger the taxation? MS of cause. MS goes to tax office and said: you got extra money because i paid more to my employee. Anything I pay to my employee is expense right? right. So my expense is more than what I reported to you previously. This means you have to pay me back because my "taxable" profit is less than what was reported. Tax office agreed and pays back MS.

Did you see the loophole? From tax office point of view, the option has been included into the expenses calculation. However the company does not report this "expense" to the market so their reported earning is considerable higher than "taxable" earning. This is precise the reason why company love stock option. If the market is efficient, meaning everyone know this trick, then the accounting of option doesn't matter that much. However the market is not efficient, meaning someone is believe MS indeed made that amount of profit as they reported to the market. Those uninformed investors will pump more of their money into MS than it desired. This generate at least two negative impacts
1) It will push the stock price of MS higher than it should be, and
2) It will starve other companies (who report the real earning) get properly financed.

Believe it or not, some years ago, almost 1/3 of cash in flow of MS is from tax office due to this massive tax pay back.

Re:Tax Implications?

[Kheturus]

Announcements made my the FASB affect GAAP (Generally Accepted Accounting Principles). GAAP is used when reporting financial information for the purpose of investing, either in public or private markets. Financial rules regarding taxation are somewhat related, but not necessarily the same. The IRS must set taxation laws, not the FASB, which is actually not a government institution per se. These new rulings by the FASB will only affect how information is reported to investors, but will have no effect on how the company is taxed.

Re:Tax Implications?

[Anonymous Coward]

Companies have two sets of financial records. One set of records for paying taxes and one set of records for reporting earnings to shareholders. Companies have been expensing options for a long time on their tax books and not on the financial reporting books. So the latest requirement to report options expense on their financial books will not have any tax implications since the options are already factored in for tax purposes.

Re:Tax Implications?

[jj_johny]

Here are the tax implications on non-qualified plans. When you exercise them, you pay the taxes on the difference between the exercise price and market price. So any money you get even if the exercise but hold the stock results in a big tax bill - on the order of 50%, state, federal, FICA, etc. Most companies are pretty good about requiring you to pay the taxes right then and there. This is good so that when you exercise the options and the stock tanks, you have already paid the tax bill. A lot of geniuses in Silicon Valley got themselves into hot water by exercising but not paying the taxes right then and there. And remember the IRS does not let you get out of your back taxes through bankruptcy.

So the question I always had when the companies said that it was not compensation was why am a paying a million dollars in taxes. I clearly got a benefit that the company could have gotten if they had just sold the stock.

One of the basic rules of accounting is that you can't get to a different result from two different direction. So when I get a million dollars but the company does not show it as compensation or even an expese but if they had given me a contract that said you get X dollars for every dollar that the stock price goes up, they would have to expense that.

Re:Tax Implications?

[merky1]

Us has a similar system, you are only taxed on the proceeds of selling your shares.

For example, if you are granted 1000 shares at 6, and you sell 1000 at 9 for a profit of 3000, your tax liability would be on the 3000.

Re:Tax Implications?

[voisine]

This already happens. Stock options have been counted as an expense for tax purposes for a very long time. Remeber back durring the boom how Cisco payed no taxes even though they were one of the most profitable companies in the tech industry? It was because they reported stock options as an expense to the IRS and not to wall street. I think a better solution to all this would be simply to tax coporations (at a very low rate) on reported profits. Don't let them keep two sets of books. It'll help keep them honest. If they lie about profits to wall street, then they have to pay taxes on profit they didn't really make.

Re:Tax Implications?

[kindbud]

Employees already have to report profit from exercise of options as income.

Re:Tax Implications?

[EnderWiggnz]

unless you buy and hold and end up paying AMT... then things get really screwy...

dismal option

[Doc Ruby]

Stock options don't require the company to spend any of its revenue. So giving them reduces profit on the books, while it doesn't affect the profit of which the stock represents a share. How does this make sense at all?

Re:dismal option

[guidryp]

But this does dilute share holder value. It is the equivalent of printing more money. It dilutes your share in the company. IMO companies shouldn't be able to just create more shares at a whim.

Re:dismal option

[samael]

Either they have to create new shares out of nowhere (diluting existing ones) or they have to go out and buy shares at market prices and sell them at the option price, which _is_ an expense.

Either way round this should be reflected in the accounts of the company, and a notional value which reflects the effect on the companies stock seems to be the easiest way to get this across to your average investor.

Re:dismal option

[Anonymous Coward]

It doesn't really matter if it costs money right now. It's an outstanding liability because it may cost them cash in the future.

Re:dismal option

[Tanktalus]

Maybe.

Some companies actually have stock "on hand" to sell as options. That is, if they "print" 50,000,000 shares, they keep back enough shares to "sell" in options, with expired options going back to the corporate-owned pool.

Then, if you were a regular investor owning, say, 50,000 shares, you would own 0.01% of the company. The fact that the company owns maybe 1% of itself means that you own 0.01% of that as well. So, until your duly elected officers (board of directors) sell these shares to its employees in a shareholder-approved stock option offering (well, a bit more complicated than that), your shareholder vote is worth more.

But that's not really that different from your electoral vote in government: people who show up to the polls dilute your vote. If everyone stayed home, your vote is suddenly "worth" more. And all those other damned voters keep creating more voters at a whim. (Well, it takes 18 years to mature into a voter, but that's a minor detail ;-})

Re:dismal option

[jedidiah]

However, stock options are in effect a promisory note so they should at the very least be treated like a debt. Options should not be completely free for the corporation offering them.

Re:dismal option

[stratjakt]

It keeps companies from treating stock like their own private money printing press. Whats that? You want a raise? Well, how about a billion shares instead! Two billion!

The .com bubble was inflated with "stock options", and everyone found out that their 100,000 shares of ComputerCo weren't worth shit after they'd given away 100 ga-jillion shares.

I'm not sure how a company calculates the value of the expense, though, since the shares are generally given away when they have nil, or practically nil value. Usually as soon as the stock is worth anything at all they just print up another jillion shares.

I'm no accountant though.

I'm just in favor of making it harder for corporations to think up "creative" ways to "compensate" employees without actually paying them. The "promotion in title only" as an alternative to a real raise is something else I wish something could be done about.

Re:dismal option

[Doc Ruby]

But if the company can print more money, it isn't money. Doesn't this mean that companies now can purely artificially create fake "value" in the economy by issuing stock options, thereby changing the value of the issued currency? Doesn't this give the DJIA Top 100 the same kind of power over the money supply as the Federal Reserve? Isn't that a total catastrophe?

Re:dismal option

[iamwahoo2]

Not true, because when I buy stock, it is an infusion of capital into that company. If I pay to much for the stock, it could actually inflate the value of the stock owned by the current share holders

Re:dismal option

[Doc Ruby]

If they go out and buy shares at market prices, or any other, that *is* an expense, and is accounted traditionally. If they create new shares, diluting existing ones, that is not an expense to anyone. It is a loss of value to the investor, but so is a drop in price on the market. Are we going to let corporations take tax credits against losses sustained in the market?

Revenue - costs = profit, which is divided by shares for earnings per share. That's economics, plain and simple. Throwing fabricated expenses makes it more complex, and totally broken. Dilutable shares is a simple risk concept that is most easily communicated to investors by describing it in exactly those terms, and no other. If you can't understand that, you are a fool to own a piece of a company, and a company is foolish to let such a fool own it. And we are fools to allow it, let alone encourage it.

Re:dismal option

[Doc Ruby]

So they printed up fake money in options. People were fools to take it - it wasn't money. Everyone knew it would only be money for a select lucky few, but of course they would be in that select few, right? The dotcom bubble was the 1990s "junk equity" version of 1980s "junk bonds".

What we're doing with this rule is make the junk equity actually be money. That makes it worse.

Re:dismal option

[EnderWiggnz]

but shares in treasury are not counted when calculating EPS, so reissuing shares does have a dillutive affect.

Re:dismal option

[Doc Ruby]

Sure, it's a potential liability, like booked business before billing. When it actually costs them money, it's an expense. Otherwise, it's just a risk - accountable, important, but not a hard financial transaction.

Re:dismal option

[Doc Ruby]

But they're a reverse promisory note: not "I promise to give you money", but rather "I promise to take your money" (though less money than I could take without this note). They are a contract, not an actual exchanged value. Options are really more like coupons than debt. And coupons, until redeemed, have a facevalue of negligible hundredths of a percent each. Which seems like a good model: assign a facevalue to each option of some nominal value, like 0.01% of a share. Upon execution, the option's difference in value from the market value is accounted as a loss by the seller (assuming the option stays "afloat"), just as it is now, in the "price - option = loss" on equity equation. Simple, accurate, and just like what we do now. And completely opposite to this preposterous rule.

Re:dismal option

[Anonymous Coward]

Options don't create shares at a whim. Options are exactly that, an option to buy an existing share. Shared to cover the options are created by approval of the shareholders as with any other share. Typical stock plans for companies include a certain amount of shares for employees as well as other purposes.

Re:dismal option

[lrucker]

I'm not sure how a company calculates the value of the expense, though, since the shares are generally given away when they have nil, or practically nil value

Not always. Sun gave stock options with a 1-year vesting period when the options were at $170. One year later they were about $15. I can't believe they were crazy enough to think it was going to go *that* much over $170, so basically it was a way to look like they were rewarding us without actually doing so. If they'd had to expense the options, they might've decided to give actual cash instead.

(Yeah, still bitter)

Expensing Matters

[smack.addict]

It should make a difference since failing to expense them hides an actual corporate expense. By expensing them, you can read a company's financials and have a better picture of the state of the business.

Re:Expensing Matters

[markdj]

What is the expense that has been hidden? If the owner of the options never exercises them, then there is never any expense incurred buy the company. As has been said elsewhere here, this is a liability. Only when exercised does it become an expense. You are confusing a grant with an exercise.

Enron

[b0lt]

If only this happened before Enron...

Re:Enron

[Anonymous Coward]

This has nothing whatsoever to do with Enron's accounting issues.

Well, that's that

[TippyTwoShoes]

My options at $95 (currently trading around $15) are still worthless. The options I just got are a little under the water too. Can't say I'm upset that options might stop coming, my employer might finally have to start giving our raises!

stock options are already accounted for

[dh003i]

Stock options are already accounted for in the dilution of shareholder ownership:

However, in one case the shareholders suffer dilution in their proportional ownership of Intel, and in the other case they suffer a reduction in the value of the company itself as it has given up an economic asset. OTOH, a company cannot count its own shares among its economic assets. ...
Shareholders can be diluted in their ownership, OR they can experience a loss in the value of what it is that they own, but trying to pile one loss upon the other is simply absurd.

Re:stock options are already accounted for

[Anonymous Coward]

Thank you for that! God, I love mises.org. I can't remember where I read this, but someone was saying something like, "The problem with redistributing wealth is that the people who know how to do it, aren't inclined to do it."

In this case, the problem is that the people who know how to properly account for stock options, aren't inclined to force companies to follow government-imposed rules.

Re:stock options are already accounted for

[TheWizardOfCheese]

No they aren't. You can easily prove this with a bit of arithmetic. Take this example:

Shares outstanding: 100
Revenue: 1,000
Expenses: 900
Earnings: 1,000-900 = 100
Share price: 20

Say that salaries account for $600 of th $900 expenses, and that a 3-year call struck at $25 is worth $5. Now suppose that half of the salaries are paid in options. That works out to options on 60 shares.

Original earings per share: 100/100 = 1

Now, if we don't count the options as an expense, and merely dilute the shares, we reduce expenses to 600, and therefore increase earnings to 400:

Earnings per share without dilution: 400/100 = 4
Diluted (but still bogus) earnings per share: 400/160 = 2.5

However, if we counted the options as an expense, earnings would be unchanged, and thus earnings per share would remain at their true value, which is $1. The reason that simple dilution fails is that effectively dilutes earnings for only one year, whereas the true effect of share issuance is to dilute earnings in perpetuity.

Re:stock options are already accounted for

[dh003i]

Sorry, but you've assumed the thing you're trying to prove. In your

Expenses = 900

You've assumed that $600 of that is salaries. Of that $600 in salaries, you've assumed $300 is paid for in stock, which you call and expense.

Expenses:
Salary: $600
.Salary paid in cash: $300
.Salary paid in company stock: $300
Other: $300
..Net: $900

You've thus assumed the very thing you're trying to prove. Simply using math doesn't allow you to commit fallacies.

Contrary to your statement, dilutions do dilute permanently. In effect, a dilution is an inflation of the number of stocks available. It's effects are lasting.

You, and anyone else who wants to mandate expensing options for the company the employee works for, are confused about assets, equity, and expenses. An expense has to be the expenditure of an asset. A company owns cash or other companies stocks -- those are its assets. If it uses them to pay employees, that is an expense. Yet, a company does not own its own stock. That is not an asset of the company. Quoting from Lloyd:

First, a company's own shares have no scarcity value to the company as it can create new ones effectively at will without significant cost.

Secondly, a company cannot own itself, as all internally held shares are actually owned by the external shareholders and whose existence is thus of no economic consequence to anyone.

Re:stock options are already accounted for

[TheWizardOfCheese]

Sorry, but you've assumed the thing you're trying to prove.

You aren't sorry at all - you are wrong.

You've assumed that $600 of that is salaries.

Yes. To assume a figure for salaries is a logical necessity of the exercise. The example I gave has two parts, A) without options: assume $600 in salaries, and B) with options, assume $300 in salaries. The exact numbers aren't important; the point would remain if I had said A) $600 and B) $599.

Or are you trying to say that option grants have no influence whatsoever on salaries? That you would not accept $1 less in salary in exchange for options? In that case, why would a company ever grant you an option?

Simply using math doesn't allow you to commit fallacies.

My point exactly. The fallacy being that expensing options somehow "double-counts" them.

Re:stock options are already accounted for

[dh003i]

Except, expensing stock option grants given by company A for company A's stock and accounting for a shareholder dilution is double-counting. Also, as I clearly explained, it doesn't make sense to expense these type of stock options, because the company's own stocks are not an asset it owns. It doesn't (and can't, and shouldn't) put them on the books as an asset. Thus, there can be no expense.

My point wasn't about the exact numbers. It was about the fact that you're assuming what you're trying to prove. Simply because the employees got $600 in salary does not mean that the company had an $600 expense. This can easily be demonstrated by the following fact: some external agent (outside of the company) could have paid them, as part of an agreement with the company.

Thus, to say that employees got $300 in stock options for their company does not necessarily mean the company incurred an expense. Rather, the shareholder ownership was diluted. The stock grant cannot be an expense, because the company cannot consider its own shares an economic asset. An expense is "the outflow of assets or the incurring of liabilities (or both) during a period". As stock options of the type we're talking about are neither an outflow of an asset or an incurring of a liability, they cannot be called an expense.

Re:stock options are already accounted for

[oblivion95]

Finally! Someone posting here with some logic! The discussion at the mises link is particularly enlightening, though not particuarly light reading. Thanks.

Efficient markets, flat earth and other theories

[magictongue]

Exactly, "If markets were truely efficient this wouldn't make a difference" - why not expense the option. It would make the math easier. Logically, when the market takes options into account by being truely effiecent then actually taking them on paper should not change anything. The only reason to hide the expense of stock option is if markets are really not efficient.

Pleasing Warren Buffett

[Anonymous Coward]

"...the tech industry is strongly opposed to the rule, though it should please Warren Buffett."

There is something to be said for corporate governance and accounting being in line with what investors want -- they *do* have an equity stake in the company, right? -- so why is the tech industry so opposed? Because they realize too many inveestors are so myopic that they cannot tell the difference between stock prices and the viability of a company? I've wondered for a long time if it might not be a better idea for direct stock ownership be limited and for the masses to only buy things like mutual funds for exactly this reason. When too much emphasis is placed on earning per share, then anything and EVERYTHING to boost that number, including taking expenses that don't have to be listed as expenses, are employed by myopic CEO trying to please myopic investors drones...

Re:Pleasing Warren Buffett

[smack.addict]

It tends to be the institutional investor who focuses on EPS. Home investors tend to do so for a variety of reasons, including having a pretty logo.

Ah, the wailing and gnashing of teeth.

[AltGrendel]

As all the geeks on /. try to figure out what this means.

Re:Ah, the wailing and gnashing of teeth.

[hsmith]

i have read it four times and i have no idea what it means accounting is not in my future, i shall stick with programming

Re:Ah, the wailing and gnashing of teeth.

[Anonymous Coward]

As all the geeks on /. try to figure out what this means.

But it won't stop them from pretending like they know what it means.

Re:Ah, the wailing and gnashing of teeth.

[Anonymous Coward]

To which Jesus replies: "It's weeping, not wailing you insensitive clod."

Re:Ah, the wailing and gnashing of teeth.

[Eccles]

i have read it four times and i have no idea what it means

So accounting is a lot like Perl...

Re:Ah, the wailing and gnashing of teeth.

[AltGrendel]

You are correct. That's what I meant, but the original post reads ok.

It's about god damn time.

[xxxJonBoyxxx]

For all of the privately held companies who compete against publicly traded companies who pay out stock options like Monopoly money...this rocks.

The surest way you know a company knows what its doing is if it's turning a profit. This should take one more accounting trick away from the pretenders out there.

What does it matter...

[Emperor Shaddam IV]

I haven't received any stock options that ended up being worth a crap since the 1990's. Who cares anymore. Be a contractor and make more money then the employees. Then you can buy your own stock!

Option value

[Anonymous Coward]

When it's granted the option has an intrinsic value of zero, but it's *extrinsic* value is more. Let's say the stock price S is 100, and the option exercise price K is 100 too. You could exercise the option today and make a profit of S-K = 0. That's the intrinsic.

In a year's time, the stock could be worth more than K, in which case the option's intrinsic value will be S-K, or it could be worth less, in which case the intrinsic value will be 0.

The extrinsic value of the option is what it's worth in the market, and presumably what it will be charged at in the accounts. It's calculated by taking the expected intrinsic value at expiry.

For our example, let's imaging there's a 25% change of the stock being worth each of 70, 90, 110 or 130 in on year's time (we'll assume it can't take any other value). The expected value of the stock in a year's time is 100 just as it is now:

E[S] = 0.25 x (70 + 90 + 110 + 130)
= 100

However, the expected intrinsic is...

E[max(S-K,0)] = 0.25 x (0 + 0 + 10 + 30)
= 10

So the value of the option is 10.

Of course, there's more to it than that. The distribution of possible stock prices is continuous. We've also ignored the fact that I'd a dollar today is worth more than a dollar in a year's time. There are theories on how to value these things...

Re:Option value

[Ignignot]

The distribution of stock prices is not continuous. They are generally quoted in cents, so you can't trade for less than a cent. This is important when you have an option that is far out of the money (nowhere near the underlying price, and intrinsic value zero).

Not to mention that you neglected the expected return of the stock, but that's ok for this crowd.

Re:Option value

[Anonymous Coward]

Strong explanation from the parent who's obviously been through a corporate finance class.

This is exactly why the options should be expensed. The company gave away options that a normal investor would have paid $10 for today.

Some people say that the options are hard to value, and no one knows what they're worth. It is extremely easy to value things when there is a ready market for them:

Chicago Board Options Exchange quotes

If the stock price plummets, the company gets an unexpected boost, because the call options will be worthless. If the price shoots up, then the company has to take a charge when the execs cash in. Simple.

Re:Option value

[Anonymous Coward]

The extrinsic value of the option is what it's worth in the market, and presumably what it will be charged at in the accounts. It's calculated by taking the expected intrinsic value at expiry.

In fact, expected value pricing is not used. This was the great discovery of Black-Scholes and Merton. As they realized, arbitrage will drive the pricing to the equivalent cost of running a hedge that perfectly simulates buying the option.

Re:Option value

[fermion]

This seems way complex. From a lay point of view the cost of stock options should be (1)the value that that stock might be sold for if it were not given away to the employee or (2) the cost of acquiring the stock that will then be given to the employee. If I pay $10 to an employee, that is the money out the profits. It does not matter if that money comes from the cookie jar, the garage sale, or borrowing from a bank. Like the corporate tax code, the complications come from the firms desire to have sanctioned fibs.

For upper management stock options, if not backed by zero-percent loans shill loans, can clearly build loyalty to a company. For the average employee stock options are nothing but a way to externalize labor costs in an effort to manufactur profit. It also can put an employee in serious financial and tax trouble since the average person is ill able to navigate the financial landscape without a good advisors. The advisors, of course, are often paid for by the firm, and employee stock options are sometimes used as a cheap way to keep the market cap up.

This has been too long coming. As berkshie-hathawy stated, I believe in last years report, transparency dictates the stock option be used intentialy, and be reported. A significant part of the dot com fantasy of free money was stock options, and it is one it's last remnants.

Re:Option value

[Anonymous Coward]

Parent is intuitive but completely WRONG on its valuation of options. This is an ancient scam. Suppose stock is at $100, Option is $100 option to buy in 6 months. Suppose also stock is 99% likely to drop to $90. Suppose also stock is 1% likely to raise to $110 (classic binomial case).

On the parent's expected value evaluation, this option is worthless. Under black-scholes and binomial, this option is worth exactly $5.

If someone is willing to sell it for less, say $4, I can make money risk free (arbitrage) by buying 2 options for $8, selling one stock short for $100. In six months, it does not matter whether the stock went up to $110 or down to $90, I make $2. If it goes down to $90, then I cover my short for $90 and thus I received $100, lost $90, and spent $8 for a $2 profit. If it goes up to $110, I cover my short and exercise both options thus I received $100, lost $110, spent $8, and exercised for $20 with again a $2 profit.

If someone is willing to buy the options for more than $5 (say $6), then I sell two options for $12 and buy one stock for $100. Six months later I sell the stock. If this price is $90, then the $12 earlier makes up for the $10 loss and no one exercises. If the stock price is $110, then I made $10 on the stock, got $12 for selling the options and pay out $20 when others exercise their options on me. In both cases I make $2.

In summary, option prices should be valued on their expected volatility, not their expected value. The big problem with using Black-Sholes on employee stock options is that people are not allowed to sell short on the stock so as to convert their options into cash (i.e the market is not efficient).

So Black-Sholes stinks but using expected value for options gives even more misleading values. Employers talk about options as if expected value was the way to value them but always say they use black sholes, yet refuse to let you sell your shares. I dont know if they are ignorant or dishonest.

Employees just beware I guess and do not be fooled by expected value or by Black Sholes without the opportunity to sell short on shares.

Re:Option value

[Anonymous Coward]

This is important when you have an option that is far out of the money (nowhere near the underlying price, and intrinsic value zero).

That's the kind I've got. They're negatively motivating.

Re:Option value

[lrucker]

You could exercise the option today

I've never had options where that was the case. It's usually been a minimum of 1 year, and more often spread out over several years, and it's contingent on still being employed by that company when it vests.

Re:Option value

[Anonymous Coward]

If someone is willing to sell it for less, say $4...

Wrong-o.

Arbitrage would not persist. Why in heaven's name would I sell the option to you at $4, if I can profit just like you do?

Let's look at it from my side, as the option holder. I would hold the 2 options, no change in $. I would also take out the short you suggested. I have a 99% chance of 2 worthless options if the call price goes down to $90, but I gain $10 from the short. I have a 1% chance of losing $10 in the short, but calling and selling stock to gain $20. Net is $10.

I'm sorry, but my 2 options together are worth $5 to me. You will have to get them for $4 apiece instead of $5 from a bigger fool than yourself.

This is why we have options exchanges to value these things on the open market. See another AC above about that.

No

[Kohath]

There are no tax implications. The FASB is not the IRS. The IRS would have to make a seperate rule.

Here is the FASB's FAQ

[rmcd]

The FAQ from the Financial Accouting Standards Board is here . You can download the actual statement from this page.

This change would have occurred 10 years ago if Congress hadn't interfered on behalf of companies trying to hide their largesse from shareholders. The rest of the world is in the process of implementing a similar accounting treatment of options. The US would have looked idiotic to have delayed this further.

Re:Here is the FASB's FAQ

[stevesliva]

The US would have looked idiotic to have delayed this further.

That's never stopped us before.

Re:Here is the FASB's FAQ

[Aidtopia]

The rest of the world is in the process of implementing a similar accounting treatment of options. The US would have looked idiotic to have delayed this further.

And the US would never do anything that would make it look idiotic to the rest of the world.

Money,,,

[t_allardyce]

I seriously think I should have gone into the finance industry instead of tech. After all its just another stupid system with rules you can learn and twist to your advantage, damnit I should have realised early on that the only job that matters is the one that makes the most money - hope its not too late to get some good profits..

Re:Money,,,

[Kaduco]

I'm just graduating from a master program in information systems, and we interact a lot with the accoutants. The interesting part is that the systems people earn about $10,000 more per year than the accountants (and I'm at a top school for accounting). So yeah, there are rules, and it's a system, but it doesn't pay as well as tech.

Re:Money,,,

[smack.addict]

You might want to get educated on the finance industry before you go off making idiotic comments like this.

Re:Money,,,

[superpulpsicle]

The financial industry is only good if you plan on working there 10+ years. Rarely do people start in the finance world and become an immediate impact. Their salary is mediocre for years and years, I am talking 20k to 30k a year. Young techies can still rake in more.

Re:Money,,,

[kraut]

Of course you can work as a techie in the financial industry - and it seems to pay better than techie jobs elsewhere.

Buffet's pi reference

[Anonymous Coward]

http://www.snopes.com/religion/pi.htm

It wasn't Indiana. It was Alabama.

Re:Buffet's pi reference

[hab136]

It wasn't Indiana. It was Alabama.

It was Indiana. The reference you cite is talking about a hoax; Indiana actually did present a bill.

Choices

[Migraineman]

As with all things accounting, the company will probably be given a bunch of choices as to how they do their accounting. All choices are "acceptable," as long as they're consistent. That'll guarantee another set of confusing and essentially meaningless statistics for the bean-counters to mull over.

When an option is granted, the strike price is supposed to be the FMV of the share, possibly minus some discount absorbed by the company. If the company isn't trading yet, they pretty much have the ability to define the price by consulting the ouiji board. Now, the option may have an exercise restriction on it - you, Joe Peon, can't exercise the option until X years have passed. That means the option has zero-value to you, but doesn't necessarily mean that it has zero-value to either the company or to the IRS. I envision two choices - Choice A: the company can expense the option at the time of grant; Choice B: the company can expense the option at the time of exercise. The former has the penalty that the company may expense options that ultimately aren't exercised (i.e. the employee quites before the restriciton period expires.) They'd probably have the opportunity to de-expense unexercised options at that point. The latter choice only taxes exercised options, but tends to defer the accounting event to a point later than what I think was intended.

I'm sure there will be much heated discussion amongst the bean-counters to choose the method that will benefit their industry the best.

Good intentions, poor execution

[groberts65]

I understand the intentions behind this - keep the fatcats from padding their wallets. However, this really punishes those companies that do share the wealth, such as the one I work for. Companies which reward options throughout the ranks will be much less likely to do so now and that really penalizes the little guy. Options will become only a tool of the well to do now.

Re:Good intentions, poor execution

[smack.addict]

You are deluded if you think this is a good idea. Except for small start-ups, options are always worth more to the company giving them out than the employee receiving them. You are much better getting the equivalent in cash or some other form.

Good news

[Degrees]

The place I used to work for gave its employees a 15% discount on buying stock (once per fiscal quarter). Every year during open enrollment for benefits, management pointed out that this program lets one buy $100 dollars of stock for the price of $85, and then turn around and dump it the next day for market price (or hold onto it, as might be your want) I'm told quite a few people did the immediate dump plan.

The people who lose in this scheme are the purchasers of stock at full price. The cash flow out of the company dilutes the value of the company, making each share of stock worth (a tiny bit) less. Some people pay full price, others (insiders) reap a benefit at a discount.

The requirement that these discounts are accounted as expenses, puts a dollar amount on them. Thus, someone (and outsider) looking at the company financial statements gets a clearer picture of where the money is going. They get to make a more informed choice.

Its a good thing.

Re:Good news

[ntropic]

Not quite. You are mixing up an employee stock purchase plan vs. an employee stock options plan. The one you refer to is an employee stock purchase plan wherein employees are given a discount on the FMV for purchasing stock. In a stock option plan, the employee is granted an option (valid for a number of years) to buy stock at a price fixed at the current FMV. If the stock goes up in that number of years, the employee can exercise (and sell immediately ) the stock options without neccessarily investing any money of his/her own. In a stock purchase plan, the employee has to fork out his/her own cash just like in the open market but at a discounted price. The expenditure on the part of the company to enable this discount in such purchase plans is already expensed today (the monetary value of this expense is known at the time of purchase), and the company then uses a particular tax rule that was supposed to promote employee ownership of the company, to get tax rebates. The accounting rule in question here applies to the stock options which when granted have no real value. The value is monetized if and when the options are exercised.

Re:Good news

[TheWizardOfCheese]

You are confused. Grants (or discounts) of stock are already treated as expenses (for the employer) and income (for the employee.) The news is that stock option grants (or discounts) must now be treated in the same sensible manner.

Re:Good news

[Degrees]

Thank you for that. ntropic pointed out my mistake as well - and I am glad that am I now less confused.

I'll never claim that I'm not confused - just less confused. ;-)

Re:Good news

[Specter]

Unfortunately you're incorrect. Expensing stock purchase programs is straight-forward and relatively easy. You know the values of all the variables; just go work the sums.

Expensing of stock _options_ on the other hand requires a bunch of guess work about what the stock might be worth when and if it's ever exercised. Guesswork that the company has a lot of leeway in deciding. The end result is another opportunity for financial statements to be come more confusing and for unscrupulous companies to manipulate their earnings.

Easy answer for those it matters to:

[mzwaterski]

For those employees receiving stock options, I'll break this matter down to simple terms for you:

If you liked receiving stock options: This is bad for you.

If you didn't like receiving stock options: This might be good for you.

This basically makes the disbursement of stock options to employees cost as much as giving cash. If you liked receiving stock options, you will be probably be disappointed because companies do not have the incentive to give them that previously existed. However, I only said that this might be good for you if you didn't like receiving stock options. Whether you like them or not, stock options do have the potential of being very profitable for you. If the expense to the company is very low, they will not have too much trouble handing them out as bonuses and such. Now, with an expense tied to giving stock options and with as tight as companies are currently, these stock options may begin to try up only to be replaced by...nothing. IANAEA (economic analyst) but as far as I can tell, we are still in employer's market or possibly close to a balance, thus, large bonuses to attract employees are not currently in force.

Black-Scholes

[krysith]

My guess is that they will most likely use The Black-Scholes Option pricing model with a few refinements.

Translation

[segfault7375]

What this means is that unless you are an executive of the company, you can kiss stock options goodbye as part of yearly salary increases and/or signing bonuses. I have just found out recently that my company has stopped giving options to new hires, it will be interesting to see if we get blocks of options when annual reviews come around. If they don't, I'll bet we don't get better raises either :-/

Re:Translation

[stratjakt]

Good, I'm tired of worthless stock options or meaningless "promotions" in lieu of real raises measured in cold hard cash.

These are scams invented by corporate HR departments to get away with paying you less without you realizing it.

Ever go into a yearly review, hear how awesome you are.. So awesome in fact, they're promoting you to "vice-manager-general"!

Your job duties are the same, but you get a nifty new title. Oh and sorry, you dont qualify for a raise. Sure you've been there two years, but now you have a new "title" so you have to wait a year to be reviewed in your new position.

Wait.. wait.. Dont quit. Here, take a bajillion shares of stock instead! They're worth 0 now, but in a year they could be worth 10 points (of course, if that happens we'll print up seven bajillion more to make sure that WE keep our cash).

They used to be able to pay employees with worthless stock and not even have to call it an expense. How is that compensation if it's not even an expense to the company?

This is a good thing, corporate america needs more rules.

Re:Translation

[RhettLivingston]

No, these are ways to at least try to give you something without paying more taxes. This doesn't eliminate that because the IRS is separate and will need to make a change in their policies too, but, rest assured, the part of your wish that stock options go away will be granted soon.

Companies were using this because iIn most situations, the cost to the company per real dollar put in your pocket is less using this means than raises.

Larger raises will not occur in place of the elimination of this funnel. Furthermore, since the total real cost of getting X dollars into an employee's pocket (the cost that includes the taxes that the company pays in your name that is above and beyond that shown on your stub) will increase, the ability of corporations to compensate employees will decrease thus decreasing the ability to keep very high end employees and causing a decrease in stock value.

As usual with more regulation everyone loses except the extra bureaucrats employed to manage the regulation.

Re:Translation

[Zed2K]

Can't pay the mortgage with stock options. I'd rather not get them. I'll take care of saving for my retirment instead of relying on the company's "good will".

A Couple of Articles on the Matter

[Prince Vegeta SSJ4]

link HERE

HERE

Honest book keeping is all we ask

[amightywind]

Expensing stock options is simply honest book keeping. Companies who ignore option payouts simply dilute the value of shares purchased honestly in the market. It is a slimy practice that used to go unnoticed. Real shareholders have been ripped of by option holders long enough. This is a good thing for anyone who is not an insider and purchases stocks will real money.

Black Scholes

[dnadig]

Out of the money options are FAR from worthless, and there's a very large body of economics devoted to this:

http://bradley.bradley.edu/~arr/bsm/model.html

Most companies use black scholes (or the public options markets) to price their options for accounting purposes.

Sorry, the math is a LITTLE more complicated than everyone's making it out to be.

Re: Black Scholes

[bender647]

The employee incentive options that I've received aren't publicly tradable. When they vest, you can buy the stock, or not, but you can't sell the option itself. Not before it vests, or after it vests.

I'm not convinced option pricing theory for options freely traded in the exchanges should be used to price something that you aren't allowed to sell.

Re: Black Scholes

[Anonymous Coward]

BS does not assume that the securities can be traded. BS is a part of continuous time finance, not general equilibrium.

The Microsoft Story, case in point

[freality]

In case you haven't heard, Microsoft (MSFT) has been deeply unprofitable since 1996, when it began to rely on holes in the GAAP accounting standards that allowed it to report historic profits in its NASDAQ filings. Large fund managers bought into it to the tune of hundreds of billions of dollars, making MS at its peak ($700B) which for comparison made it the largest component of the S&P 500, the equivalent of the 16th largest country or ~1.5% of the GDP of Earth. Though billed (no pun intended) as a success story, when the bubble burst investors lost billions.

Who cares? The biggest funds involved were pension funds of large social programs across the US, e.g. the California Teachers Union, who automatically invest in S&P components at rates proportional to the components' value. MS paid for its bottom line with those peoples' money, so much so that pensioners are majority owners of MS today. Too bad for them that the bottom fell out of MS stock and their savings are worthless. But it did help create two of the richest personal accounts on Earth.

You could argue that this was all legal and that they won the king of the hill prize. Perhaps. But is it ethical to block GAAP reforms via corporate shills in Congress (e.g. Joe Lieberman) so your huge losses won't be exposed? Enron execs are being hung out to dry for being only slightly on the other side of that thin line in the sand. No, it's likely MS knew what it was up to. As Bill Parish, who broke the story, tells:

"Microsoft's perspective is best reflected by Bob Herbold, Chief Operating Officer, to whom the CFO reports. Bob very sincerely [explained the situation to Gates], "Bill, everyone is doing it.""

This is a great vindication for Bill Parish, and another step towards reigning in widespread corrupt accounting practices. http://freality.org/~pablo/essays/microsoft.html

Re:The Microsoft Story, case in point

[HeghmoH]

To me, your story about the teachers' union is not so much a condemnation of bad accounting practices as it is a condemnation of idiotic, blind investment strategies. If their plan had been something more than "pile it all on the S&P 500 and hope for the best", they wouldn't have been screwed so much.

Re:The Microsoft Story, case in point

[cheekyboy]

If they purchased gold using 50% of their cash, they would be up... 100%+

And who said economist are smart? its just a big follow the leader herd.

financialsense.com is ur saviour

Re:The Microsoft Story, case in point

[virtual_mps]

If they purchased gold using 50% of their cash, they would be up... 100%+

And who said economist are smart? its just a big follow the leader herd.

financialsense.com is ur saviour

haha, you're one of those wackos who think that pretty yellow metal has some mystical intrinsic value! talk about herd-following...

Re:The Microsoft Story, case in point

[Anonymous Coward]

What a load of shit. The "bubble" you talk of was not perpetuated or caused by Microsoft's employee options plan. It was the tech boom - many, many people were suckered and burnt by it, and Microsoft's stock was not the only stock to be inflated by the boom.

Furthermore, now that your article is woefully out of date, and Microsoft is reporting its employee stock plan as an expense, Microsoft is still posting record profits. They have continued to post double digit growth over previous years that Parish claims were artificially inflated. Does this mean that Microsoft's business has actually grown stronger over the last few years and the so-called lies have become truth? Even with the stock charge, Microsoft's business is one of the most profitable around. 3 billion dollars a quarter. That's more than the entire market cap of Red Hat every three months.

It is an incredible irony that you are still touting this article and pointing the finger at Microsoft when it has changed its reporting practices. Peharps you should point the finger at "do no evil" Google who still engages in the corrupt practices you despise.

I'm a former Enron employee

[GodBlessTexas]

As a former Enron employee and stock option holder, it wouldn't have made any difference for us. What brought the financial issues to light was the failed Blockbuster Video on Demand project that Enron Broadband (the company I worked for) booked profits for when there were none. Then, when the deal failed, it was hard to cover that up. They were putting profits on the books that didn't exist, and would have continued to do so even if they had been forced to record the stock options as an expense. It's likely that they might have lied to an even greater extent in that case.

Enron, specifically Jeff Skilling, wanted to drive the stock like an Internet stock during the .com boom. And that's exactly what got them in trouble. Now the stock is worthless, unless you have the actual printed stock certificates, which have collectors value now.

Re:I'm a former Enron employee

[EnderWiggnz]

yeh - enron's big faux-pas was revenue-recognition. they would book entire value of contracts, that were not stable, when the contract was signed, and before delivery of product.

really really bad moves on their part.

startups win!

[ngreenfeld]

Options in a large, established company, especially a public one, have a clear value and those companies will probably curtail use of options.

However, startups usually have no profit early on anyway, so options still make sense for them! More loss looks OK, because later when (hopefully) they turn a profit and it just looks like they grew more.

So the bottom line is: get into a startup very early, before they really have to worry about "profit" in the accounting sense.

Re:startups win!

[stupidfoo]

Webster:
Internet Startup: Small fledgling companies that lose lots of money and never make any. Typically are out of business in 2-3 years.
Usage: "You quit your job to go and work at a Internet Startup??? YOU F@CKING IDIOT!"

Re:startups win!

[tji]

That may have been true in the days of the Internet Bubble, when companies were valued by a really optimistic view of potential future earnings. But, in today's market, even startups need to show real potential to turn a profit.

Depending on how these changes work in practice, option costs could easily outweigh the meager profits of a company just getting started.

Re:startups win!

[envelope]

Ahh yes, I remember going to work for a startup. I got options at about $8 per share. The stock is currently worth about 5 cents per share.

Dodgy Accounting

[Anonymous Coward]

The problem with this proposal is that it attempts to fix dodgy accounting by introducing more dodgy accounting.

Stock options are not granted by the company. They are granted by the shareholders. Every stock option grant I recieved, even from a small, no longer here startup, was granted by the board of directors, not the executives of the company.

The shareholders of the company basically offered me a deal that if the stock price of the company is greater than the strike price, then they would allow me to purchase shares of the company at some strike price. Essentially the shareholders of the company incurred a future liability equal to the number of shares times the difference between the actual price of the stock and the strike price.

HOWEVER, rather than show this liability on the books of their investment business, investors shift the potential future cost of the options back to the company. Remember a corporation is a legal entity, so what we have is a shift of liability from one legal entity, the shareholders or venture capital firm, to another legal entity, the corporation.

Interestingly enough this is exactly how Enron worked. Enron created a large number of shell corporations and made Enron's books look better by shifting income to the parent corporation and shifting liabilities to the subsidiaries. This is a classic technique in fradulant business practices, namely moving liabilities off of the books of one corporation. But I digress...

Back to the issue at hand. Institutional investors, rightly, are annoyed that these future liabilities aren't accounted for properly. Unfortunately, their mechanism, is flawed. Ideally, the liability of future options would be shown directly on the books of the owners of the company, not on the company itself. The investors aren't going to do that as it makes their investment business financials look bad.

Given that the shareholders shift the burdon of funding exercised options to the company, then this liability should be treated as a future debt, not like a current expense. When a company takes a loan, they expense the payments as they are made, not the entire amount of the loan up front.

Stock options are not an expense. They are a debt instrument, like a loan and should be accounted for as a liability on the balance sheet and expensed when the options are excercised and paid off. At that point, you remove the options from the liability side of the balance sheet.

Re:Dodgy Accounting

[Anonymous Coward]

I think you have misconceptions about accounting.

The board of directors IS the executive head of the company. It is appointed by the shareholders, but it doesn't necessarily contain any shareholders. It's like the way that the Whitehouse and Congress interact - yes they work closely together in practice, but they are not the same thing.

You also don't understand what a shareholder is. An equity share is literally an interest in the business. Liabilities on the end-business are owned (by shares) by the shareholders just like the assets are. If the shareholder is an investment company any increased liabilities in the investment will be reflected by writing-down the asset on their balance sheet. Shares are different from debt and different from financial derivatives. They reflect ownership in a straightforward way.

Please do not compare a proper accounting practice that links expenses to the company that incurs them to Enron. Your salary is reflected in the company's accounts. why not your options? To follow your scheme seems to me an Enron-ish way of making your employees look cheap by "hiding" their bonuses onto apparently unrelated firms.

When you create a provision, double-entry requires that you make a second entry as an expense in the Profit and Loss for the year (or whatever it is in the US, I am talking in IFRS terms). If you are lucky enough to be able to cancel a provision you make the second entry as a profit in the year you no longer need the provision. This is how double entry works, and has worked for centuries. You recognise liabilities as soon as you have a reasonably quantified view of what they are. Even if that provision is not 100% accurate, it is better to have an estimate than to pretend it doesn't exist. This is the "matching concept".

The Titanic should have taken avoiding action as soon as the icebergs were foreseeable, not after it had hit them. Your company should foresee a reasonable chance of a loss when it grants the options, not at excise. If the actual situation turns out to be slightly higher or lower than the option it doesn't really matter, because at least there was some recognition in the accounts.

Re:Dodgy Accounting

[Anonymous Coward]

"When a company takes a loan, they expense the payments as they are made, not the entire amount of the loan up front."

No, a payment of loan principle is not an expense. A loan doesn't get expensed, it gets repaid, and the interest over time is an expense.

Stock options ... should be accounted for as a liability on the balance sheet

And where do you propose to record the debit side of that liability (you have heard of double-entry bookkeeping, right)? It's either an asset or an expense, and you say it's not an expense, so what's the asset related to the liability? (Hint: there isn't one, so it's an expense, just as the FASB says.)

Employee stock options and the lottery...

[human bean]

have much in common, particularly the part about options expiring at zero value. It's interesting that the FASB considers this in the same light.

Of course, we all know who gets rich from the lottery, don't we? I never understood people who accepted company stock as bonuses, payment, etc. From where I stand, when the company starts handing out shares instead of cash, it's time to start looking around.

Re:Employee stock options and the lottery...

[Anonymous Coward]

Like the lottery, it's a bet.

Do you take the cash in hand or do you "spend" some of the cash for stock options. The question is which is larger, the present value of the cash or the present value of the future amount of money you get from the options.

I've played the game twice. Once it was a wash. I got something out of the options when the company was sold, but I probably broke even on the value of the salary I "spent" to work at a startup. Once I won, not enough to set me up for life, but enough to fix up my savings rather nicely.

At the time I was single and fresh out of school, so why not play the startup game?

Now with a wife and kid, I'm not inclined to play the game now. I need a stable income, not a chance at a large chunk of change.

Re:Employee stock options and the lottery...

[mzwaterski]

If company A offers me x dollars a year and company B offers me x dollars a year plus y shares of stock options...I know which I'm choosing.

Stock options are not some evil thing that means a company is going to spiral downwards. Treat stock options like stock options and not cash. Do some work to determine the likelihood that the stock options will be worth the money. Discount the stock options when comparing cash with options, but I wouldn't discount them to zero. Not all investments have a 100% chance of success. Heck, even cash is a gamble, albeit a rather small one. But look at the devaluing of the USD$ as an indication of how even cash can be a gamble. What if you had been given the option of USD$ vs. Euros five or ten years ago. If you chose USD$ you'd be unhappy right now!

Does this mean *all* stock options?

[whitroth]

If so, then I'm not interested in us peasants, 90% of whom get little-to-no stocks, but I want to know that Bill the Gates, and Kenny-boy Lay, and Eisner, and all the rest of the CEOs with tens of *millions* in stock options have to be expensed.

Gee, what might happen to all that money if it didn't go to CEOs? Maybe it would get wasted on utterly frivilous things, like better employee salries and benfits, and maybe even capital plant development!

Nahhh, never happen, ship it all off to India.

mark

to add to your post

[Prince Vegeta SSJ4]

there is also the Put, which is the opposite of the call more or less. When the strike is greater than the stock price, you can 'put it to them' meaning, if you are long (purchased, given) a put you have the right to sell shares to the writer (seller) of the put at the strike price.

of course you can also short calls and puts as well.

options have an intrinsic value, which is related to the price of the stock and a time value which is related to the length of time to expiration. Time decay sensitivity is measured by Theta.

There are various other measures as well, DELTA is similar to the Beta of a stock price and measures the cahnge of the option price with respect to the stock price.

VEGA is a measure of volatility

RHO is the measure of price w/ respect to interest rates

GAMMA measures the change of DELTA with respect to the stock price..

For all you number crunchers out there, you can download a program to calculate these values (if it hasnt changed since I used it) as well as the black's scholes values as well. HERE

I recommend the textbook as well, as it talks about many types of strategies with options as insurance/hedge devices, etc.

Here's my take

[alecf]

As I understand it you're close, but not quite there. Its not an expense or an income per say, but a debt owed to the owner of the option. As a result, the options should be recorded in the "Liabilities" section of the accounting statement that every public company must release quarterly. So before when a company said it had $1 million in liabilities (debt), now it might say that based on the current value of the stock, it has $1.2 million: $1 million of specific debt to whoever they would have recorded normally, and $0.2 million in debt that the company might have to pay if people cashed out their stock options on that day.

So for instance, if I am granted 1000 options at $10 and this quarter the stock closed at $15, then on that day, the company "owes" me $5000 - meaning if I cash out my stock options on that day, then the value is paid out to me essentially by the company.

On the other hand, if the stock closes at $8 on the day the quarter ends, then I would be a fool to cash out my options, so the company owes me nothing and I owe them nothing. So the extra liabilities there are $0.

There's no need to predict future value of options. Options have a very specific value depending on the exact price of the stock.

On a related note, I'm curious how companies actually fund the value of options. The company could end up buying those options on the open market on the day they issue them to you (buying them cheaply and thus playing the risk that the stock price actually goes up) or they may buy them at the moment you exercise them - essentially funding the entire value of your options. I dunno.

Thank you for that

[Degrees]

When I'm mistaken, it is best that someone corrects me.

If I understand you correctly, then this ruling changes the reporting for "Wealth - Value of Remaining Options" in the ninth column on this page - but only after those options are exercised.

Do I get it now?

Bill Gates has never had options in MSFT

[winkydink]

He owns his shares outright.

I think it means...

[Spy der Mann]

Maybe we can relate this to something that is happening in Mexico recently. Instead of being given a share, employees are given other "comodities" (i.e. food/expense tickets, etc) that are NOT reported as the worker's salary. This means the reported salary is much lower than it actually is.

When the employee retires, they only give him a compensation regarding his REPORTED income, not the real one. This way the company saves millions by giving its employees money in a different denomination.

I *THINK* that somehow, this is what happens with stock shares... that the company is saving taxes / other payments because they give their employees other kind of money, and not cash. That's why the shares must be reported now. Obviously, companies don't like it because they see lost profit in it.

Someone correct me if I'm wrong, please.

Re:I think it means...

[sserendipity]

A simplified explanation:

Option grants aren't share grants - they are:

1. worthless when granted, since they are valued at the same price as the stock on that day.

2. Become excercisable over a long period of time (4-5 years, usually). You can only excercise them while you are still an employee, so the only way to get them to be worth anything is by staying at the company until the price rises.

So, no, they aren't just a way of paying employees in a different way - they are more a promise of payment in return for future work, which, in a small part is dependent on the quality of work of the employee in question.

NON-DILUTIVE ONE-TIME EVENT

[blair1q]

The net effect of stock options is the same whether you expense them at grant or at vesting or at exercise or at expiration.

This accounting rule just makes it more clear in the prospectus how much the extant option pool affects your risk as a speculator (don't get me started on the difference between retail stock and investing).

Bottom line, it's a wash. Top line, it's a huge win for shareholders and prospective buyers. And the corporations won't change their option plans just because of this, unless they're too stupid to see that the accounting method doesn't affect the morale-boosting premium value.

Balance

[Lord Bitman]

Employees are paid in stock options. Now these must be counted as and expense. This causes the company to not show a profit, which decreases the stock value, which reduces the expense shown, which allows the company to be shown turning a profit, which increases the stock value, which increases the expense, decreasing the profit, and so decreasing the expense.
A little bit of statistical analysis shows that every company practicing this will have a profit of approximatly (on average) 50 cents this year. So, now is the time to buy.

option are not money, but have a strike price

[slew]

At the day of the grant, even if your company is not public, they have to make a fair estimate of the value of the share price.

Often when a company starts, they do something stupid like saying each share is worth $0.001 par value (1/10 of a cent), there are 10 founders, and a VC investment of $5M dollars and everyone gets some certain amount of shares and the company has the right to issue some more share in the future which potentially dillute the current shares. So at this time, if you are issued 10M shares, that's considered a $10,000 grant.

Then when the company raises the next round of financing they go through the process of saying, hey, this new investment is worth either more or less than the previous round (depending on factors like if the company is making money, or if they are spending it like it is going out of style and what the perception is on the future viability of the company), any they may say something like if you put in another $10M, we'll give you 100M shares. This instantly sets a new benchmark where each share is worth $0.10 (100x gain). This means that the $10,000 in options is only 100,000 in share this time. Usually before the company raises the next round, they anticipate when this will be required in the constantly updated business plan and interpolates the price per share between the financing rounds.

Why do they go through this complication? Well it's because theoretically the risk is higher earlier and the change in price/share is suppose to reflect the risk premium and the easiest way to try to determine this in a non-biased way is to factor in what new investors in a company think is the current price/share value. Also many of the corporate "agreements" between the investors and the management (like those written in stock plans and compensation policies, etc.) set guidelines and limits for issuance of options based on strike price ($/share) and % of ownership (usually it requires a good faith conversion must always be made of the current value of a share to prevent issuance of a strike price that is lower than say 85% of the current estimated value for a joe employee, or a 110% of the current estimated value for an executive).

Although this may seem completely aribtrary to do this interpolation based on the financing rounds, often these things need to be done to both attract future investment and to avoid certain personal and corporate tax consequences of a company issuing something of value to an employee w/o causing an employee tax liabilty (and triggering withholding taxes on that value), for more information on this you can read up on the so called qualified "incentive stock option" provisions or the qualified employee stock purchase plans in the relavent US IRS rules.

Of course, after a company goes public and is widely traded, the price per share does not usually need to be interpolated anymore...

This says it all

[Anonymous Coward]

"The rank and file at the companies that were giving out what were largely symbolic option grants will generally see those disappear,'' Rosen said.

To the rank and file, the "symbolic" grants can make a huge difference. 10-30k that a rank and file employee might make from options may actually improve their lives. Its the rank and file employees that could use the "symbolic" grants. Everyone else is already getting paid shitbags of money.

Rich get Richer.

The valuation is still wrong

[GlobalEcho]

[I was a quant working at a major bank until leaving this year]

Putting a value on those options is itself a matter of some contention. Basically, employee stock options (ESO) nearly always have a strike K bigger than the current stock price S when they are granted. The value of the option lies in the fact that it is reasonably likely that at some later date, K>S.

So, a foolish measure of value would be intrinsic value: i.e. MAX(0, S-K). There is a formula called the Black-Scholes formula used for pricing options with only one allowable exercise date, and no other special features. That formula is quite inappropriate for pricing ESO, since ESO come with lots of other quirks, including vesting periods, stock holding periods, employee attrition, and (not least) lengthy time intervals in which they are exercisable.

Of course, to accountants even the BS formula is exotic. Rather than using a proper model (hinted at in FASB 123 with the moniker "binomial model") to price the options, accountants prefer to use BS, and then "adjust" the results as they see fit to account for the various features. The results of this are better than just using intrinsic value of course, but not by much.

I developed a model for the bank to use in pricing its ESO. It was reasonably correct, in the sense that it used the traditional approach of a trinomial tree to model the stochastic process followed by the stock price, along with code to account for the various quirks of our options. It still had manipulable inputs, such as volatility, but at least accountants would have to have justified their values.

Of course, internal politics killed the model in favor of the BS formula, and arbitrary accountant's adjustments. If that's what happened in a major bank, with the generally stated goal to transparently publish numbers, and with guys like me around to develop models like that...well, how much are you going to be able to trust the option expenses published by other companies?

I hope that FASB fixes this, and deprecates the use of the BS formula in inappropriate contexts.

Re:The valuation is still wrong

[0WaitState]

Bravo--but there's a downside to ESO's you left out, that they are typically exercizable for only about 6 weeks of every quarter (until you leave your job, at which point you are usually free of restriction). In my anecdotal experience employers will declare blackout periods from 4 weeks prior to 1 week after quarterly earnings announcements, and other corporate events cause other unscheduled trading blackouts.

I complete agree that Black-Scholes is largely BS. What really needs to happen is to allow employees to sell a subset (10%?) of their vested options on the open market--that will create a fair valuation of them.

Re:The valuation is still wrong

[truesaer]

The key here is that any substantive discussion on the method hasn't really been able to take place because the only people floating that are those who don't want to expense options at all.

Once expensing opponents get past that and realize that expensing WILL happen, then perhaps they can make a valid argument on why a different model will be better. But "Black-Sholes isn't quite right so lets not expense them at all which is way way way wrong" is not going to work.

Re:The valuation is still wrong

[khallow]

So, a foolish measure of value would be intrinsic value: i.e. MAX(0, S-K). There is a formula called the Black-Scholes formula used for pricing options with only one allowable exercise date, and no other special features. That formula is quite inappropriate for pricing ESO, since ESO come with lots of other quirks, including vesting periods, stock holding periods, employee attrition, and (not least) lengthy time intervals in which they are exercisable.

Hmmm, as I recall, Black-Scholes can be applied with modest modification in the cases you describe. The restrictions on exercising the ESO, the vesting, etc don't appear to me that arduous. The stochastic differential equations get more complicated, but that's doable. Other assumptions like geometric normal distributions of securities prices may be less justified.

However, I don't see any reason to knock your valuation model. I'm not sure of the subtle differences between these discrete models and Black-Scholes, but the former apparently often converges to the latter in its continuous limit. Maybe you should have tried to sell it as a discrete Black-Scholes?

Re:The valuation is still wrong

[khallow]

I complete agree that Black-Scholes is largely BS. What really needs to happen is to allow employees to sell a subset (10%?) of their vested options on the open market--that will create a fair valuation of them.

You lose a lot of the flexibility of these options if you have to standardize them for a securities market. Otherwise you run the risk of markets so illiquid you can't get fair value. For example, if I'm the only person who has 10,000 options of a certain type and I don't sell them, then what's fair value?

Re:The valuation is still wrong

[0WaitState]

Why would you be the only person with a paltry 10,000 shares in FooBarCo? Home mortgages of all sorts (including those with terms not falling on 15, 20, and 30 year boundaries) are bunched and resold in the bond markets. Why can't 10 year stock options with a fixed exercise price be sold this way?

Re:The valuation is still wrong

[khallow]

Hmmm, I guess that would work. I still think the market would be pretty illiquid compared to home mortgages. After all, we're still talking several orders of magnitude in difference in the size of these markets. But the underlying derivatives are very liquid and the valuation models for these options would be well understood. So it should be manageable.

I like the immediate valuation aspect here too. Ie, the company can rapidly unload these long term obligations by paying others in the market to take on them.

Re:The valuation is still wrong

[GlobalEcho]

The Black-Scholes formula itself has narrow application: namely to vanilla options with European exercise. I believe you are referring to the Black-Scholes stochastic model, which of course has wider applicability. My solution was actually a solution of the Black-Scholes model with boundary conditions germane to ESO.

The features and restrictions found in ESO do not require a model other than Black-Scholes, but they do generally introduce path-dependence (even early exercise implies path-dependence), and thus make the formula inapplicable even if the model itself remains valid.

Path-dependence nearly always requires approximate solutions to the Black-Scholes SDE. One can argue whether these approximations themselves are models or not. For example, the binomial model is indeed a model, though in the high N limit it converges to the same thing as analytic solutions. However a trinomial tree is not a model, as it fails to eliminate arbitrage. Nevertheless it is perfectly functional as a technique for obtaining approximate solutions to the PDE, and converges to the continuous limit faster than binomial trees do.

Speaking of models, one could actually argue with justice that the Black-Scholes model is not particularly well suited to ESO due to the long maturities involved, and that some sort of stochastic volatility model is called for. Unfortunately, such models are a real pain to parameterize in a way everyone agrees on.

Re:The valuation is still wrong

[GlobalEcho]

Oh, I'm certainly not arguing that expensing should not happen. I simply wish they would have gotten the specification correct, right from the start. Proper valuation is now going to require another fight.

Re:The valuation is still wrong

[GlobalEcho]

Actually, I did put blackout periods in my model. However, they do not affect the option value as much as you might think (at least to extent that stock prices follow the Black-Scholes stochastic model).

The reason is fairly simple: the blackout periods turn an American-exercise option into a Bermudan-exercise option with relatively frequent decision times. Just a few decision dates manage to capture most of the value difference between European and American exercise.

To address your point about selling options on the market...the idea is generally sound, but does not entirely capture the asymmetry between ESO and market options. For example, a certain number of employees quit every year, relinquishing their options. This attrition (in the company's favor) should be modeled and estimated, though it obviously doesn't apply to other market participants.

Employees also should be expected to value options and the resulting stock less than the market as a consequence of their inability to hedge properly; they are not allowed to sell short, and often must hold stock resulting from option exercise for a year or so. Though their subjective valuation clearly has no direct bearing on what the firm's option valuation ought to be, it does affect their exercise decisions in a way that will reduce the option value indirectly. This too can be modeled. To see this, think about the following: if you had a one-year hold restriction on the resulting $20,010 stock, would you be willing to exercise your options that were (in total) only $10 in the money? You shouldn't be, as the $20,000 in the bank you could otherwise keep will have far less volatility.

Re:The valuation is still wrong

[0WaitState]

Thanks for the insight. Speaking anecdotally again, I have not seen any ESOs with a one-year hold requirement besides that for the tax benefit. In fact, most ESO exercises I've known of have been cashless exercises with immediate sales of the shares.

Where did you work?!?

[yndrd1984]

I need to send them my resume...

I should point out that the shareholders are losing money, not the company. The distinction may seem trivial, but there is a big difference:

Let's say my company made a million dollars, and then printed enough stock certificates to double the number of shares. The company still has the million, but the shareholders now own half as much of the company as they did before. The company didn't spend any money (except printing costs, ect.).

The shareholders should be told how many outstanding shares there are and how many were (or will be) printed and when. But to say that the company lost money when they acually have more dollars (or more equipment, or less debt, or whatever) is really a lie. As the article says it needs to be disclosed, I just think it should be on a different line of their quarterly report than their profit/loss.

Of course, if they buy the stock from someone (rather than printing more), then that is an expense, just like when they buy anything else.

Yndrd1984

Re:Where did you work?!?

[HardCase]

The shareholders should be told how many outstanding shares there are and how many were (or will be) printed and when. But to say that the company lost money when they acually have more dollars (or more equipment, or less debt, or whatever) is really a lie. As the article says it needs to be disclosed, I just think it should be on a different line of their quarterly report than their profit/loss.

The shareholders must approve employee stock purchase plans at their annual meetings, so the shareholders not only know how many shares are available for employee purchase at a discount, buth they also explicitly authorize it! In approving these plans, the shareholders balance the effect of stock dilution against the value employee morale.

-h-

Re:Where did you work?!?

[Degrees]

You are correct - primarily the shareholders get stuck.

I was thinking of something that I did not include in my post: the company has announced a plan to buy back stock. That is where the company will actually be out cash, and be worth less. Your point is right: the discount really only affects shareholders.

It doesn't help that I was confused about employee stock purchase plans versus employee stock option plans. See this post by ntropic.

Re:Where did you work?!?

[EnderWiggnz]

>That is where the company will actually be out
>cash, and be worth less.

why? wouldnt they be buying a fairly liquid commodity, in their stock, with cash? this is just moving assets from one vehicle to another, and there should be no material affect in their overall net worth.

in addition, companies generally only buy back when they believe their stock is trading under fair market value, so the company expects to be able to sell the bought-back shares at a higher price than when they bought.

I like ESPP's for big, stable, slow-growth comapnies, and ESOP's for small, explosive-growth type companies. I've worked at both types, and made real money with both plans.

If you're working in the tech industry, you really need to understand these compensation schemes, and be able to determine which fits your needs best, and how to maximize your personal return.

Re:Where did you work?!?

[Degrees]

You have a good point - although the devil is in the details....

I can see where it looks like a lateral translation, trading one form of asset for another.

As I understood it, buying back your stock is something you do when you cannot think of something better to do with your cash. Yes, the assumption is that you buy back the stock when it is undervalued - and in theory the stock will go back up.

On the other hand, I don't have faith that the company won't crash and burn like Enron or WorldCom. Two days following the stock buyback plan, the company announced, due to a lack of cash, austerity rules: no more free coffee, travel, training, raises, etc. Ummm... WTF? The other thing I didn't like about the company's financials, is that (in 2001) 48% of its assets were catagorized as "Good Will". This may be 100% legit, as the company is a services organization. The bulk of the company's growth is from mergers and acquisitions. But hundreds of millions of dollars in "Good Will" still makes me queasy. So for this particular company, the details make the value of the company have a somewhat ephemeral quality.

From this point of view, when you see cash outgo for stock buyback, it appears you are losing hard value, and gaining soft assets. Really soft assets.

I have to agree with you that it looks fine on paper.

Just don't expect me to buy stock in the company.

But I do concede your point - generically, a company does not lose value when buying back stock.

The Matching Principle

[Idou]

requires public companies to match revenue with the associated expense incurred in order to generate that given revenue. Otherwise, the economic activity would not be properly represented.

Say you are going to give a Christmas bonus to your employees depending their performance over a six month period. Though you will not pay cash until December, you will actually have to charge 1/6 the expense every month in order to properly time the expense as the bonus is being earned.

For stock options, I believe you have to set a "vesting period" and charge over the vesting period, as the employee "earns" the stock option. I guess the amount you would charge would have to be the estimated fair value at that point the stock option was fully vested, or earned. After the stock option is earned it should have been fully expensed because it is no longer contributing to Revenue by motivating your employee to work. Though the company must honor the option amount after it has been earned, the change in price should have been reflected in the fair value (present value of the entire life of the option) that you charged during the "earning period."

No, the idea is to have as little taxable income as possible while showing the highest reportable income as possible. There are differences in how the two are calculated, but I see no indication that the stock option calculations will be different. I have to check, but I believe the method of calculation is pretty much standardized based on some formula that uses past price fluctuations, not much room for manipulation.

The difference is that investors (and other stakeholders) will only be concerned with the number that includes stock option expense because that is the number that will be comparable to other companies, including those that do no issue stock options.

if markets were truly efficient....

[realitybath1]

entropy wouldn't exist. aka: the applied economist's pipe dream.

Phantom Stock Plans

[YodaToo]

In the nonqualified plan arena, phantom stock plans are generally accounted for on an as-you-go basis. It seems qualified stock plans will no be tracked in a similar manner. More info here under "Accounting Issues."

accounting require consistancy

[Anonymous Coward]

Unfortunally, GAAP (generally accepted accounting principles) want expenses to be recorded nearest to the time when they logically impact the company to prevent a company looking good on paper by deferring big expenses to the future to make things look good today to detect problems as soon as possible possibly prevent defrauding current and new investors.

If expenses need to be logically spread out over time, then they can be acruued (and reversed/recaptured if there is no exercise because of expiry), but that's something that has to be justified. I don't think a case can be made for deferring an expense like that to the time of exercise under current GAAP guidelines (which is likely why FASB went the direction they did)...

I think the bean-counters are mostly represented by the FASB folks, the tech industry rain-makers, on the other hand, will of course want to choose the method that makes the current scheme of minting money continue unabated...

Accounting is Not Mathematics!

[stress4dad]

This just goes to show you that accounting, while a valuable discipline for business and government, is not mathematics. As a mathematician that has worked in government, education, and industry, I am still befuddled by "accounting". Some examples are the use of the Black-Sholes formula for stock option pricing to determine Employee stock option value, when the underlying mathematical system assumptions for the B-S formula to be appropriate do not hold.

Some other accounting favorites...

Accounting vs. Math/Statistics

Accounting Variance = Mathematical Difference

Accounting Volatility = Mathematical Variance

Whatever accounting is...it is not math, I am convinced.

Re:Accounting is Not Mathematics!

[Colazar]

One of my accounting instructors said that accounting is the language of business.

As one who majored in Linguistics, and is now an accountant, I can say that that is absolutely true. All accounting is is the way that business information is easily (?) communicated.

Efficient Markets

[Threni]

> If markets were truly efficient, this wouldn't make a difference

Huh? Which column this or that entry goes in a company's accounts has no bearing on the efficiency (or otherwise) of the marketplace. Anyway, the proof of the EMH (or at least the lack of any successful attacks on it) has done nothing to stop people throwing good money after bad in managed funds, so I fail to see how this will make any difference.

Footnotes, anyone?

[rice_burners_suck]

I don't like this FASB hogwash. If you look at the way most of our accounting standards are put together, an "expense" is some transaction that reduces net income. What's going to happen when corporations start putting together their financial statements? All I can say is that it will make all kinds of "weird" stuff happen to the numbers, and the final net income number will be understated by some arbitrary number that means nothing, in my opinion.

I'm opposed to this simply because it's an additional "exception" in the rules that must be handled. Worse yet, there is no number that you can get off any other financial papers... You must estimate the value of the stock options, which means that the FASB has created yet another way for creative accountants to play shady games with the numbers. Sure, it'll look official enough, and all your earnings will be understated.

I wouldn't be surprised if this value is deducted after taxes, just to add insult to injury, but honestly I haven't kept up to date on this as much lately so I don't know where it goes on the income statement...

But seriously... What's wrong with showing how much money you really made, and then disclosing stock options in a footnote?

Re:Footnotes, anyone?

[Anonymous Coward]

Um, corporations already put together their financial statements.

This standard has been expected for some time, not to mention the fact that FASB gave corporations the option to report compensatory stock option plans this way years ago.

A great example of a company ALREADY following FASB Statement 123 (Fair Value method) is Coca-Cola, who adopted this method in 2002. (BTW, this is the method that companies now have to follow.)

Unfortunate for us plebes

[jay2003]

The executives will continue to grant themselves massive amounts of options whether they are counted as an expense or not. Public companies will probably for the most part just quit granting options to the rest of us so FASB just decreased most of our potential compensation. Thanks alot FASB!

There's no accurate way to estimate the value of an option regardless of what the accountants tell you since doing so requires a crystal ball. The accountants could not stand that that somebody figured out a way to incentivise employees that only cost a fraction future shareholder gains (which may not exists without motivated workers) and wasn't an expense so they are killing it.

Wiki link - Option values

[wren337]

Mod parent up, Black-Scholes is the most common way to value options. It uses expected volatility in the stock price together with the time horizion until the option expires to calculate a value. A lot of trading sites (etrade, anyway) will calculate option values for you using this model.

http://en.wikipedia.org/wiki/Black_Scholes

Wiki link - Re:How will it work

[wren337]

Expected volatility and option time horizion are used to calculate option value.

Black Scholes

I still think this is bad accounting

[markdj]

I have posted on slashdot about this before!

I still think this is bad accounting. Options when granted don't cost the company anything and no money changes hands. They are NOT a cost or an expense. They are a future liability - the difference between the current price of the stock and the exercise price of the grant.

When the options are exercised the liability goes away and their accounting depends on whether new stock was issued (they dilute everyone else's stock), they were purchased on the open market (a real cost), or they were sold to the exercisor from treasury stock (reduces retained earnings).

Re:I still think this is bad accounting

[Anonymous Coward]

If a company takes out a loan at La Cosa Nostra Loan Shark Service for $100 on the understanding that it has to pay $200 in the future, that's an expense even if La Cosa Nostra never decides to call in the loan. It's a potential liability. Options are potential liabilities, and not expensing them is hiding their existence from the shareholder. It's fraudulent.

Re:I still think this is bad accounting

[markdj]

I totally disagree. Taking out a loan is a liability and is properly reported so on the balance sheet. Making the payments is an expense that reduces that liability. I doesn't matter if the loan company is La Cosa Nostra or Joe's Bank. The difference between the amount borrowed and the amount paid is the interest. The amount of the loan is a liability because if the company goes out of business it can be made to pay that back.

Same with options, even though those who have them may not be high on the list of creditors and may not actually get anything if the company defaults. But the company does have to come up with a way to satify the exercise of an option even if it is done by issuing new stock which costs the company nothing.

Re:Dodgy Accounting - I wholeheartedly agree!!!

[markdj]

Hear! Hear! I said the very same thing in a later reply to the parent of this thread and in a reply to a previous slashdot thread.

Wont really Effect Start-Ups

[Anonymous Coward]

I recently started working at a startup company. I have a few thousand shares of stock valued at a penny a share. Oh no, now thats an expense? I make more in a day than my stock is currently worth. When the stock becomes valuable, thats when its less likely to be given a large amount of options anyway.

I don think the new law really changes anything for startups. But I'm not an accountant.

Not exactly

[Anonymous Coward]

You got the right answer but you got to it using faulty reasoning.

Finance 101 lesson:

Valuing options using pure expectations (your method) leads you to problems like the following:

Say our stock value can take one of two prices at the next time step: 90 or 110. Say our strike price is the same as our price today = 100. Assume there's a 75% chance of the stock going up in value. What's our option value? Now assume theres only a 25% chance of the stock going up in value. What's the option value?

Using your methodology the option value depends on how likely the stock is to go up or down in value.
e.g., if P(stock goes up) = 0.75, option value = $7.50 but if P(stock goes up) = 0.25, option value = $2.50.

So using your methodology we need to know the probability of the stock moving up or down. And you are left with the possibility of losing money if you are writing options.

A better way to do it is to compute the cost of constructing a portfolio replicating the option's performance no matter what the stock market does.

Using our simple binomial model (along with a bunch of other simplifying assumptions) it works out that you can construct a portfolio duplicating the option using 1/2 share of stock and a $45 loan payable at expiry. It costs us $10 to do this and we don't lose or gain anything vs. the option regardless of the probabilities of the up or down move. Thus $10 is the value of the option in this simple world.

Why is the option value the same as the value of this constructed portfolio that behaves identically? It's because if the option traded for any price other than $10, we could take opposite positions in the option vs. the portfolio and make a guaranteed, risk-free profit. This is called an arbitrage opportunity and in financial markets arbitrage opportunities tend to disappear, which is equivalent to saying that the option value will approach the price of constructing the portfolio.

I repeat because this is very important: the value of the option is not dependent on the probabilities, just on the potential stock prices.

In fact, the process of valuing options using a binomial model involves computing a expectation value after all, but one using using a pseudoprobability based on changes in values instead of the actual probabilities that those changes occur.

It gets more complicated when you assume the stock can take multiple values at some future period of time (as in your example.) The easiest way to deal with this is to shorten your time steps and assume there are two time steps between today and the expiry and working backwards. It turns out that the option value using that model is the same as the number you got, which is $10, but your model would give a different answer if the probability distribution wasn't even.

Of course in real life, time steps approach (but are NEVER equal to) zero and price moves are small (but discrete -- NOT CONTINUOUS) and you usually can exercise the option for some period of time before it expires so it gets just a little bit more complicated than the simple example above. :)

Do NOT mod grandparent up

[Anonymous Coward]

The grandparent is wrong. B/S looks at volatility but not probability, i.e., it doesn't matter what the expected rate of return on the stock price is, just how much the stock price moves around.

Using the OP's logic, the option value would be different for an upward-trending stock vs. a downward-trending stock (his uniform 0.25 probability would no longer apply).

Under B/S (the better method) the value would be the same regardless of trend as long as volatility (std. deviation of returns) is the same.

This realization that option values have nothing to do with expected stock return but a lot to do with expected stock volatility is what won the Scholes the Nobel in 1997 (Black died in 1995). It's the critical observation in modern option valuation theory.

CEO's

[Anonymous Coward]

This should stop companies from giving their CEO's stock options at less than the market price. At the last Fortune 500 company I worked at their last CEO who had bailed after 2 or 3 yrs got a lot of options at $30 a share, when the market price was $50 a share. They made some big layoffs to cut some spending in the short term and pump up the price of the stock. Then they jump ship basically taking the money saved by the layoffs with them. Its a good thing this wont be a common practice anymore.

engineers get the bulk of options?

[Anonymous Coward]

Truthfully, this is a good thing. Most options overwhelmingly go to executives who are already grossly overpaid. Now shareholders will better understand what all those VPs cost.

Er, never mind

[Anonymous Coward]

I missed a level of comments there. The grandparent I referred to up a level is completely correct and SHOULD be modded up. It's the comment before that one that gets it totally wrong.

Sorry for the confusion.

Expected Return doesn't matter.

[Anonymous Coward]

Black and Scholes showed that expected return has nothing to do with option value. This is the KEY POINT in option valuation.

Re:Expected Return doesn't matter.

[Ignignot]

he isn't using black and scholes. he's using the binomial method of valuation, which DOES require an expected rate of return. And black scholes does require the risk free interest rate, which can be considered an expected return.

Re:ignorant comment

[clodney]

Your post contradicts itself. If ISOs and NQSOs have no value until they are exercised, then you have no reason to be bothered if you stop receiving something that has no value.

But "...getting a break and making some real money..." certainly says that the options have value to you.

Which is it - do they have value or not?

Determining the value that should be assigned at time of issue is not simple, but it is disingenuous to claim that they have no value at the time of issue.

Stock options from a profitable .com.

[generic]

I work for a company that rode out the stock market boom and collapse. Our stock went from 200 a share to .50c and now has settled at 13.00. We would get stock options every year or so for 2500, or 2000 shares. I sold 12000 shares at 15.00 in may, almost all of them. Simply because I didn't want to ride the Market anymore. After taxes I had 100,000.00 in my account. More then I figured I would ever see in my life in once place. At 29 years old I already own a home and now built an inground pool to share with my wife and family. I am upset that this type of senenario will probably not occur for many other people with this new law.

Market value?

[hacksoncode]

Ok, I have 2 problems with this, and 2 questions.

Problem 1) The dilutive effect of the options was incurred at the time that the stock option plan was approved by the board. The only thing that actually granting those options does is slightly increase the chance that the dilution will come to pass sooner, but unless the plan is rescinded, it will come to pass eventually. So exactly *when* is the expense really incurred, and why should the company have to report it at some other mostly irrelevant time?

Problem 2) The kind of options granted by companies to their employees are not, *not*, *Not*, *NOT*!!!!, the same kinds of options as are traded in the options markets. Any pricing scheme would have to account for this in order to be fair.

How many market-style options have vesting? How many have 10 year exercise periods? How many of them are forfeited if the purchaser severs a contractual relationship with the company (i.e. by quitting)? More importantly, how many market-style options can the company turn around and right-out *invalidate* any time they feel like it (by firing your ass)?

Personally, I don't know *anyone* that would purchase options on these terms on the open market, so I will boldly claim that the market value of these style of options is 0. Hmmm.

Question 1) If companies have to expense options when granted, do they get to record a profit if the options are taken back when employees leave (or when the exercise period expires and the employee doesn't exercise them)? Do they get to depreciate them if they start to head underwater? If not, why not? Exactly what kind of "fairness" are we gaining here?

Question 2) If options are a (theoretical) liability that can be estimated, shouldn't companies also be able to claim an asset for the (theoretical) estimated value they *gain* by granting them to their employees?

If a company didn't think they were gaining a value higher than the cost of the options, why would they grant them in the first place? If they don't get to do this, why not? What "fairness" exactly, are we gaining here?

-5 idiot

[Anonymous Coward]

bill gates never had options in microsoft.

My Mini-Rant Against Tech CEOs

[travisbecker]

A number of Tech CEOs are against expensing stock options. Here's my argument to them (perhaps my points have been said elsewhere. If so, I apologize):

It's duplicitous to, on the one hand, say "Stock options are valuable (some say necessary) for attracting and retaining talent, and aligning employee interests with the company", and then turn around and say (both to the SEC and shareholders) "We have no idea how to value the options we give out, therefore we're telling you to assume they are worth nothing."

Yes, option expenses are currently disclosed in the footnotes, but there's no reason not to make the Earning per Share number (the one everyone focuses on) more accurate than it currently is.

Even beyond all this, in the end it isn't an issue about what investors, executives or employees think. This is an *accounting* issue, to be determined by the FASB. We shouldn't let Congress or Executives start dictating accounting policy for publicly held companies.

Travis

(On this issue I side with Warren Buffett and the writers at Fool.com rather than Craig Barrett and Barbara Boxer.)

I know how you feel

[Rufus88]

I know how you feel. I wore out the Rewind button on my VCR watching the last 10 minutes of "Trading Places".

Startups, Pre-IPO / Post-IPO

[tji]

This seems like it could have a chilling effect on startups, where a big part of the value proposition for all involved is potential option profits. If I don't get a good option package, why would I want to sign on with a startup, with loads of risk, and a relatively low salary?

While even in startups the executive option profits can be obscene. More reasonable rewards are often achieved by the rank and file developers and marketing types. If accounting changes are made, guess who will lose out? Yeah, it won't be the execs. Us little guys will no longer have the potential for good gains.

Will the equation change at all for Pre-IPO companies, where the shares are not on the open market? Can they report a share price below what it would probably go for in the open market? Can they grant shares, effectively giving ownership of the company, rathern than options - and would that make a difference?

Once a company goes IPO, it seems like this would make it tough to "get over the hump" to being a larger company where they can absorb option costs without totally killing reported profits.

Maybe it's time to look for one of those stable corporate IT jobs, with all salary compensation. The IPOs are a lot more risky these days, and reducing options will not leave much incentive to stay.

Tax consequences

[Anonymous Coward]

I'm no accountant, but if the option must be represented at current value, doesn't that imply income tax consequences for the recipient?

The company wrote the option at present value, say X. Does the individual have to pay tax on value X having received it from the company?

In the current IRS world, if I "give" you a share of my partnership (LP), then you owe taxes on that value even if no cash changes hands.

The more I look at this the worse it seems for ordinary individuals hoping to create real wealth.

This is going to eliminate stock options for us

[stry_cat]

What this is going to do is make companies not want to give out stock options to their employees.

There is no cost to the company to issue stock or even stock options (unless they decide not to issue more stock but buy on the open market). So this should be reported as a loss. Yes issuing more stock devalues the current stock, but there are a number of regulations out there to make sure everyone knows the company is going to issue more stock.

Now that they'll have to record a loss it will make the company look like it is doing poorly. Thus a big reason not to issue any more stock.

This is just an attempt by big government anti-free-market types to make it harder for the little guy to become rich and to perpetuate the old employee vs. employer fight. If all of the employees are owners this fight is less likely to happen and there is less of a need for these silly government and union bureaucracies.

This is long overdue

[terris]

Start-up founders have routinely conned contractors and employees alike with their worthless stock options as an incentive to take less pay, work longer hours, and look the other way when it comes to the founders' meglomania, lack of business sense, crappy office location, etc..

It is Jan 1 2005. You awake in a pool of your own vomit.

If you want worthless stock, go to Sand Hill Road and peddle your great idea. Work your life away only to see it stolen by extremely wealthy white men.

If you want real stock, apply for a job at a publicly traded company and put as much as you can into ESPP. Try not to get screwed.

Don't forget to clean yourself up first.

Correction

[Anonymous Coward]

but in reality, the tech industry is strongly opposed to the rule

Correction. Tech Industry executives are strongly opposed to the rule, because it allows them to essentially fraudulently print money at the expense of the shareholders and owners of the firms.

I makes perfect sense

[PalmKiller]

Obviously this needs to be done in order to keep ceo's and the like from playing the system and quoting higher than true earnings. The common employees stocks are minimal and so they are not bothering to count those, I suspect in an effort to get more of the stock dispursed to the common man to avoid stock dumping by the ceo/cfo/cXo.

From TFA, which I actually read:

First, the bill decrees that a coveted form of corporate pay -- stock options -- be counted as an expense when these go to the chief executive and the other four highest-paid officers in a company, but be disregarded as an expense when they are issued to other employees in the company.

VC Valuations

[billstewart]

My wife's previous company valued the options that way when they issued them to employees, and we had to use the of that calculation when she exercised the options as for alternative minimum tax calculations. (She'd bought some at 10 cents, some 25 cents, etc., but the VC valuation was $3.00.) But they never ended up going public, so those options never were really worth that much as stock, and eventually they gave us 5 cents a share for them when they sold off the last bits of the company.

Options have value even if not exercised

[grouchyDude]

I think this is a bit naive. Options have a value as soon as the are issued and most options are never exercised, even thought are are bought and sold.

To over-simplify somewhat, I think it's like saying we should tax milk only after it is consumed, since some people might let it rot in the fridge and then throw it away (gee, that's too familiar!). They might, but the milk has value even in the bottle and we generally tax stuff that has value.

This will *cost* the companies, I'm sure...

[JakiChan]

...because I assume they'll stop offering the stock options to the rank-and-file. Keep them for the executives. But then without that incentive they'll need to pay valuable employees more to keep them. If they won't give me stock options then they can give me cash (i.e. instead of small raise + options at review time they'll have to give more of a raise), but if they give me nothing then I go looking.

(And if you're good, it's not a down job market...)

Bad news for state pensions & budgets

[chiph]

Most of the 100+ state-run pensions in the US are already underfunded, plus they've got a lot of their money in funds based on the S&P 500 index (Microsoft makes up a large part of the valuation of the S&P 500). So what happens when someone like Microsoft has to restate earnings to comply with the new FASB standards? It's going to absolutely bust the budgets of many states for years to come as they struggle to pay their commitments.

Of course, the states will merely find experts who think they can somehow get 10..12..15% return on their money, and woot! They're back in the black!

A big problem becomes much more manageble if you just pretend it's already solved.

Chip H.

Re:Bad news for state pensions & budgets

[cheekyboy]

If they had a clue from Jan2004, they could have put all their money in EUROS, I mean christs, ask John Snow, hes whole plan is to devalue the US$, if the smart people place their $s outside USA before it happens, then bring them back after a 80% devaluation, then they come up on top, thats the plan, but if the accountants are too stupid, then let all the old people suffer, errrr... i mean the young people will suffer by paying 73% taxes, oh just let the oldies die.

I'll make this real simple ...

[Culture]

For those of you who do not believe that options are an "expense." I am going to make you a great deal and purchase options from you for 1M shares of MS at 1$ more than the current share price. I will give you $100 for them. What a great deal! You just made $100!

Clarification request

[fizbin]

So what you're saying is that, under this binomial model, the combination:
[ 1/2 share of stock, $45 liability on SOMEDATE ]
is equivalent to the portfolio:
[ Option to buy one share of stock at $100 on SOMEDATE ]

After mulling that over for a while, I can see how that's the case. What I'm having trouble with is how you determined that it costs $10 to put the combination portfolio together. The 1/2 share of stock costs $50, all but $5 of which is covered by the cost of the loan. Does obtaining the loan cost $5? Is there some cost in binding the two pieces of the loan together?

GDP != MARKET VALUE

[cheekyboy]

A GDP of a country doesnt equal a market share value of a company. A GDP is more of how much activity there was, since it does count money moving several times, ie the same $100 note changing hands 5 times a day for 365 days.

A 'market value' of a country is probably all assets/land/people. A calculated value of assets of any country would be too high to even buy, ie there wouldnt be that much 'cash' available to buy it. At any one time there is always more 'market value in assets' than available cash at hand in the system.

So MS could be worth $700B based on shares, but only $45B based on book value. But a small country like Greece could be worth 25trillion if you add all the countries companies assets + peoples assets + govt assets.

Re:GDP != MARKET VALUE

[khallow]

Well, I think GDP comparison is reasonable though obviously not the networth versus GDP comparison that the original poster made. Microsoft would then have a GDP of at most a few billion. But I have a beef with your valuation of Greece versus MS.

If we were comparing the value of MS to Greece proper, we probably should include the stock market valuation instead of the book value, and the value of the employees' assets as well and some prorated fraction of their families' assets in this calculation.

Further, I doubt that Greece has assets valued at $25 trillion. That's on the order of the entire land assets of the US at current prices, private and government. It also is roughly 2-3 times the valuation of publically traded companies in the US. A guess, I had a part in constructing, puts the US's total assets somewhere around $40-80 trillion (including the value of the economic output of its citizens) currently. Microsoft's stock would be around 1% of that value.

Readable version

[Anonymous Coward]

http://shit.slashdot.org/article.pl?sid=04/12/17/1 49238

IBM sale to Lenovo

[Anonymous Coward]

News out today appears to imply that the expensing of stock options would have increased IBM's loss in their hardware division, and this may have played a hand in their sale of the division (which had a cool $ billion in debt)

Or it could have been something else.

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