NEW YORK (Dow Jones)A recent report likens the current state of U.S. employee stock option accounting to King Kong on ape growth hormones.
The report sheds light on what critics see as a gift from the government to companies that dole out options as a key form of compensation, without enduring a corresponding hit to their bottom line.
In "2000 Stock Compensation: Sizing Up The Beast," independent accountant Jack T. Ciesielski takes aim at, among other things, the huge tax benefits that flow to S&P 500 corporations by virtue of employees' periodic option exercises.
By Ciesielski's tally, the estimated tax benefits more than tripled to $34.7 billion last year from $11.3 billion in 1997. With Microsoft Corp. (MSFT) and Cisco Systems Inc. (CSCO) taking the number one and two spots, having reported benefits of $5.5 billion and $3 billion respectively, and with other big technology companies sprinkled among the top 10 list, "the tax break amounts to a virtual government subsidy of the technology industry," he wrote.
Corporate defenders of options say that the grants are a key part of efforts to attract and retain high quality employees. Moreover, they note, corporate deductions correspond to hefty taxes shelled out by employees when they exercise their shares.
"The tax rate is higher for individuals than for Cisco," a spokeswoman said, "so the government benefits."
At the same time, in addressing the issue, both Microsoft and Cisco stressed that they strictly adhere to all tax and accounting rules.
"The bottom line is that Microsoft follows FASB's rules and U.S. tax laws," a spokeswoman for the Redmond, Wash., software giant said, adding that "Microsoft employees pay hundreds of millions to the U.S. government on stock option compensation every year."
FASB refers to the nation's main accounting rule making body, the Financial Accounting Standards Board.
While it's true that the accounting techniques companies employ are kosher under generally accepted accounting principles, Ciesielski maintains that "the vast majority of companies don't merely choose the low road; they roll around in the mud on the low road, too."
After being greeted with a firestorm of criticism in the 1990s by the corporate community and Congressional allies, FASB gave companies a choice to either recognize the fair value of employee stock options as an expense, as FASB recommended, or show the pro forma numbers in footnotes.
Five years later, only two companies "employ upfront accounting of stock compensation," he said.
Many accountants believe that ignoring the fair value of the options granted to employees is less transparent and less honest, resulting in what Ciesielski calls "hidden compensation." By culling through required financial footnotes, he found the "overstatement" of earnings increased last year to an average of 9% from 6% in the prior year.
The report provided fodder for a renewed debate over stock option accounting policy. It was the topic of Ciesielski's newsletter, "The Analyst's Accounting Observer," which made the rounds among Wall Street clients last month. The highly critical report came amid news that the International Accounting Standards Board put the thorny issue on its agenda. The newly convened body is trying to harmonize worldwide accounting standards.
Another forthcoming report by Bear Stearns & Co. accounting analyst Pat McConnell could also further sharpen the debate. McConnell, who sits on the advisory council to the international board, observes that employee stock compensation expense would have jumped 65% for S&P 500 companies last year if companies had been following FASB's preferred method of expense recognition.
The significant increase is a result of a number of factors, including a rise in the number of options granted last year as well as the phase-in nature of the financial disclosures, she said. McConnell's fourth annual stock option expense report will be hitting the Street any day now.
"I think it's another piece of anecdotal evidence that suggests that when companies don't have to account for an expense," she said, "they don't manage it." By Phyllis Plitch, Dow Jones Newswires, 2019382357 phyllis.plitch@dowjones.com
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