Peter, thanks for emphasizing that options are not expenses to the firm when the options are issued. The only problem with options is that people who don't read the notes to the financial statement may not realize that options can become both expenses to the firm and dilutive to shareholders. Options can and should be considered an incentive, but not when the firm allows the exercise price to be lowered just because the firm or the market isn't doing as well as previously anticipated.
The reason that options are popular is due to the tax system. The option buyer anticipates a capital gain sometime in the future, and will exercise the option as a way of getting what ammounts to a salary bonus at the lower capital gain tax rate. The corporation, on the other hand, gains from paying a portion of the "salary" or "bonus" or whatever you want to call it at some time in the future, rather than at present.
In my view, while I accept options as a useful tool in the present system, I would prefer to see corporate taxes dropped to low levels, such as 5 percent, and capital gains taxed as ordinary income, adjusted for inflation. This would eliminate abuses and be fairer than the present system. The only problem is that it would be politically unacceptable.
One way of handling options under the present system would be to require corporations to expense a percent of the cost (such as 50%?) once the stock price reached 90 percent of the exercise price. At that point, it could be argued that the corporation may have an expense in the near future, and so the option expense would be similar to any "set aside" (e.g., sums set aside for judgments, potential liabilities, etc.) that is now routinely accepted in the industry. This would be a better way of treating options than the way Standard & Poors wants to do it, regardless of how close the options are to being exercised.
Incidentally, dropping corporate taxes would also in effect drop the government subsidy on corporate investment, forcing corporations to take more responsibility for lousy investment decisions, including takeovers at ridiculously high prices, and other types of reckless spending that contributed to the dot.com bubble.
Art |
