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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."
-- Thou hast strayed far from the path of the Avatar.
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.
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!
There's a Mercedes gap too. I want one and can't afford one, but it's not government's job to do anything about it.
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?
--
make install -not war
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.
If only this happened before Enron...
got sig?
social sciences can never use experience to verify their statemen
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.
As all the geeks on /. try to figure out what this means.
The simple truth is that interstellar distances will not fit into the human imagination
- Douglas Adams
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.
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!
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...
There are no tax implications. The FASB is not the IRS. The IRS would have to make a seperate rule.
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.
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.
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..
This comment does not represent the views or opinions of the user.
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.
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.
"The most sensible request of government we make is not, "Do something!" But "Quit it!"
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.
My guess is that they will most likely use The Black-Scholes Option pricing model with a few refinements.
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 :-/
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.
HERE
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.
an ill wind that blows no good
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.
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.htmlAs 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.
.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.
Enron, specifically Jeff Skilling, wanted to drive the stock like an Internet stock during the
Remember the Alamo, and God Bless Texas...
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.
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.
It was Indiana. The reference you cite is talking about a hoax; Indiana actually did present a bill.
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.
*whup* "Get along, little electrons. Heeyah!"
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
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.
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.
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?
"The most sensible request of government we make is not, "Do something!" But "Quit it!"
He owns his shares outright.
"I'd rather be a lightning rod than a seismometer." -Ken Kesey
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.
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.
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.
-- 'The' Lord and Master Bitman On High, Master Of All
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...
[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.
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
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.
Sdelat' Ameriku velikoy Snova!
entropy wouldn't exist. aka: the applied economist's pipe dream.
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."
This way to the egress...
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.
> 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.
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?
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.
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
Black Scholes
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).
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.
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.
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.
Microsoft aggravates my tourettes syndrome.
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?
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. I wore out the Rewind button on my VCR watching the last 10 minutes of "Trading Places".
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.
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.
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.
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.
Bill Stewart
New Fast-Compression-only CPR http://preview.tinyurl.com/dy575ks
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.
...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...)
"Where quality is like a dead stinking rat - you just can't miss it."
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.
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.
I submitted this story last night, and it didn't get posted.
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!
----- There are two kinds of people in this world, my friend; those with loaded guns, and those who dig.
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?
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.
Liberty freedom are no1, not dicks in suits.