The great flaw in most of the option debate is that most commenters never address whether the option holders are receiving CASH compensation equal to the fair market value for their services, i.e. their labor AND they risk they take in agreeing to employment with the Company.
First, the biggest problem is ISOs. For clarity, one should still subdivide the universe of ISO optionees into management and non-management employees (since the most glaring abuses occur in the granting of options to management. However leave that aside for simplicity). More importantly, one must look at the growth stage of the Company in question.
Regarding the former (ignoring management) if the companies non-management employees receive less average cash compensation then employees in their peer group of companies, then they are certainly entitled to their share of the profits through options, i.e., the employee traded cash today for larger cash tomorrow based upon his or her belief that his or her contribution and the contribution of their peers would create value over and above the market rate of interest on the cash comp they foregoed.
Regarding the latter, the growth stage of the company is relevant because it implies an overall cost of capital. Start-ups and early stage companies have high costs of capital (one expect a larger % return correct?), mature companies low. If a mature company is giving option grants roughly equivalent in value to a small company’s grants, that is certainly a red flag. But generally it doesn’t work that way, notwithstanding the recent demonization.
Bottom line, if a company saves CASH compensation today by granting options, the employees are certainly entitled to their share of the profits through options. If the company didn’t grant the options, it would have higher cash operating expenses and lower earnings, or if the company was in a negative free cash flow situation the additional compensation would have to be funded immediately by debt or additional equity issuances (In other words employees in startup and early growth stage companies - if paid less then FMV wage rates - are essentially venture capitalists). Assuming the situation outlined above, the argument that employees are not entitled to their share of the profits via options is a “heads I win, tails you lose" argument.
On the accounting side, the basic accounting principles expressed in FAS 123 are sound - recognize the expense in the period incurred using a FMV standard. Where it gets all bolloxed up is the actual timings of option exercise and the (at least heretofore) inability to recapture the value of options previously expensed if they expire unexercised (not to mention the complexity of record keeping and the variablity in valuation methodologies which creates a real connundrum for publicly-traded companies). In the the latter case, if options where treated like warrants then the company would have a permanent increase in APIC, but they're not.
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p.s. Dan, I'm responding to the thread of post on the subject and not particularly yours. |
