Hi Don Lloyd; The gist of your argument with regard to the proper pricing of options is that even though they are like water to the company, but like diamonds to the employee, they should be counted in the income statements of the companies as if they were water.
Austrian economics is a great method for exploring the science of economics, it is not particularly well suited for exploring the profitability of individual companies. For that, GAAP is the way to go.
If what you are saying is that options are an entirely dilutionary contribution to a company, rather than a profit or loss item, then I can see your point. But the problem with taking that attitude is that you will be unable to distinguish between companies that are making excellent profits by producing goods that are worth more than the cost of goods sold, and companies that are successfully selling (diluting) their shares. I really doubt that the Austrian economists would have had great difficulty making that judgement. If the company issues too many options, they will decrease the value of those options to the rest of the world, and that is an expense which must be accrued to the correct income and loss accounts.
A COMPROMISE
Here is an example of a paper arguing that stock options should be valued at lower than the price that is indicated by Black-Scholes, but note that he does not believe that they should be priced at zero, which seems to be what you are advocating:
The Paradox of Win-Win Employee Options
The purpose of this paper is be to understand why the win-win nature of employee options has no special value within modern finance. Different underlying assumptions that return win-win to employee options are presented. The results indicate better tax and accounting treatments, as well as advice for option use.
fed.org
A great article on the recent history of employee stock options, and accounting for them is this one:
The threat that stirred them came from outside, from a group of accounting deep thinkers who had concluded that options are, in fact, not free. This was hardly a revelation. Ever since 1938, when the Securities and Exchange Commission made clear that it would leave the setting of accounting standards to the accounting profession, the American Institute of Certified Public Accountants had been wrestling with how to value stock options. The most straightforward solution--waiting until employees exercised options and counting the profits they made as a company expense (as the IRS does)--offended accountants' notions of matching expenses and income in time. In that scheme, a company might report a compensation expense in 1997, when the option was exercised, for work that had actually been done in 1988, when the option was awarded. The method AICPA settled on instead was to value options on the day they are issued, by subtracting the exercise price from the stock's current market price. If the exercise price were set at that day's market price, as was typically the case, it meant options were free.
Anybody who had ever traded other kinds of options--puts and calls on stocks, corn futures, whatever--knew this wasn't the case. While employee stock options aren't transferable on the open market, people will often pay for an option even if its future exercise price is precisely equal to the present price of the underlying security. In 1973 finance professors Fischer Black of the University of Chicago and Myron Scholes of MIT were the first to quantify plausibly the value of call options--with a formula that uses the market price of the underlying stock, the exercise price of the option, the term of the option, the risk-free interest rate (i.e., T-bills), the volatility of the stock price, and the stock's dividend yield. The Black-Scholes model transformed global finance, helping create the modern derivatives business.
By the early 1980s the accounting profession realized it had to revisit the way stock options were being treated. Responsibility for setting accounting standards had migrated from AICPA to the Financial Accounting Standards Board, an independent panel dominated by accounting-firm types but also including former Wall Street analysts and corporate executives. As is its habit, FASB took its time developing a new options standard. In 1991, with skyrocketing executive paychecks--and by extension, stock options--a hot political issue, Senator Carl Levin, a Michigan Democrat, introduced legislation urging FASB to get a move on. Still, it wasn't until 1993 that the board issued its proposal: corporations should expense options at the time they are granted, using Black-Scholes to determine their value.
The reaction from the business world was swift and fierce. Some of it focused on shortcomings of Black-Scholes. The model is best suited to valuing options with durations of months, not years. Furthermore, it relies on a variable, a stock's historical volatility, whose usefulness in predicting future value is unreliable at best.
But the opposition was also visceral: FASB was trying to kill options, and that was a terrible thing. That's what sparked the March 1994 gathering in San Jose--the 'Rally in the Valley,' as organizers called it. 'Give stock a chance!' shouted Kathleen Brown, then California's treasurer and a gubernatorial candidate, to cheers from the crowd. 'Don't stop the engine of economic growth that has absolutely fueled this California economy!'
ecompany.com
-- Carl |
