Lawmakers rush out options rules
Commentary: Plans from Washington poorly considered
By Mike Tarsala, CBS.MarketWatch.com
Last Update: 12:11 AM ET July 17, 2002
SAN FRANCISCO (CBS.MW) - The Senate passed an array of accounting reforms this week, but failed to make a decision on the issue that affects tech earnings most - whether or not to count stock options as a real cost of doing business.
Thank goodness they held off: No matter how you feel about expensing stock options, or if you even care, the proposals offered up by Washington politicians so far would arguably do little to improve the distribution of corporate wealth. Instead, they would gain publicity for a handful Congressmen who are pressing a hot-button issue.
The most aggressive of the proposals from lawmakers so far seems to be nothing but a cleverly devised tax hike for corporations -- one that will ultimately pinch shareholders. Another is a watered-down bill that only expenses a tiny percentage of the true cost of offering options, and one that can hurt companies if the options go unused.
And the lamest proposal wants to throw the whole decision-making process in the lap of "kinder and gentler" SEC Chair Harvey Pitt, so Congress can wash its hands of the issue, and still look like it performed its due diligence in the eyes of the public.
Almost overnight, proposals to expense stock options moved front and center among myriad U.S. financial and legislative issues. The detractors include Fed Chief Alan Greenspan, who claims that stock options are at the heart of the cycle of greed that created the market boom, and the subsequent bust. They even had a role in the financial accounting scandals at Enron and WorldCom.
"Too many executives sought ways to harvest some of those stock market gains," Greenspan said Tuesday. "As a result, the highly desirable spread of shareholding and options among business managers perversely created incentives to artificially inflate reported earnings in order to keep stock prices high and rising."
This week, Coca-Cola and the Washington Post agreed to fully expense options - two of only a handful of companies to account for them. The financial hit to each business is minimal, as neither corporation hands out options freely. It remains to be seen if other bellwether companies will come under pressure to follow their lead.
Momentum for expensing options is building, but there are several reasons why it has yet to catch on. The nation's tech executives are of the mind that options are a no-cost way to attract top talent, and that they give workers a theoretically unlimited incentive to work their hardest - something companies desperately need in a dismal tech downturn that's affected America's competitiveness abroad.
Analysts, meanwhile, point out that stock-option accounting could decimate the tech industry. In the computer chip industry alone, options expensing would have sent earnings lower by 69 percent, 31 percent, and 43 percent, respectively, over the past three years, according to Merrill Lynch.
On the other hand, expensing options could be a potential benefit to long-term shareholders who end up paying the price for options through diluted corporate assets, while arguably receiving none of the benefits. At many tech companies, stock options make up 30 percent or more of the total shares outstanding. As a result, as much as 30 percent of the company's market value goes into the pockets of company insiders.
Of all the groups affected by stock options, it seems John McCain had the federal government at heart when he tried to get an accounting amendment added to the financial accounting legislation passed this week. It seems his main goal was to boost tax revenue.
If McCain can revive his proposal when the House and Senate combine their financial accounting legislation, he will take away a large portion of the tax benefit companies can record for offering stock options.
McCain's legislation would require companies to account for options one of two ways - the most attractive way being using the Black -Scholes method, which assigns a theoretical value to the cost of the option, and expensing it over the stock option's life.
Here's how it might work: Let's say Microsoft issues five-year options at a price of $50, and in 10 years, the stock goes to $100, and let's assume Black-Scholes assigns a value of $10 to the cost of the option. Under current rules, at the end of the contract, Microsoft needs to cough up $50 a share, and it gets a tax benefit based on the $50 a share it paid. The employee ends up paying a $50 per-share tax bill.
Under McCain's proposal, the employee still ends up paying a $50 per-share tax bill. But the employer can only get a tax break according to the Black-Scholes value of the contract - which is $10. It's a hidden tax - one that ultimately will be paid by Microsoft's investors.
Another proposal, favored by Senate Majority Leader Tom Daschle, would let the Financial Accounting Standards Board, the group that brought us GAAP accounting, decide the accounting issue. The FASB also favors use of Black-Scholes theoretical values in determining the value of options contracts.
Herein lies a problem: Let's say in the Microsoft example that the $50 stock option gets assigned a Black-Scholes value of $10, the company continues to carry the option on its books for five years, and near the end of the contract, the stock drops to less than $50.
Microsoft has still paid costs for the option, which it's amortized on its books - even on a stock options contract that will never be exercised by the employee. The company and its shareholders take a hit on a perk the company never really offered.
And perhaps the biggest problem with Black-Scholes accounting is that it only records anywhere from 10 to 50 percent of the true cost of an options contract, says Don Luskin, analyst with Trend Macrolytics in Menlo Park, Calif.
Call me a simpleton, but what's wrong with companies recording the full cost of offering the option - in Microsoft's case, $50 it reports to the IRS -- once the options contact is exercised? Then there's no need for theoretical mumbo jumbo.
You'd think someone from Washington would figure that out.
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Mike Tarsala is a San Francisco-based reporter for CBS.MarketWatch.com. |
