I support the expensing of stock options, as stock options are a form of pay. If salaries and bonuses are expenses, so are stock options.
However, there's a lot of confusion (to me, at least) about how valuable the stock option is and what it should be expensed at.
Here's an example. Bob is granted to buy 10,000 shares of Digital Datawhack Corp (DDC) at $10 a share, exercisable 5 years from the time of the option grant. DDC is trading at $10 at the time of the grant.
How is this option valued?
An option 2 years out already has a value established by the market, at least for many companies: the LEAP (Longterm Equity blah blah) for that stock. For example, the LEAP for DDC at $10 with an exercise price 2 years out might be something like $1.50. Meaning, someone is willing to pay $1.50 a share for the right to purchase DDC at $10 in 2 years, regardless of the actual price of DDC at that time.
For such a stock option granted to Bob, a 2-year option, granting him an option to purchase 10,000 shares at $10 is effectively giving him _today_ something that is worth $15,000. In fact, DDC could simply buy that LEAP on the open market and hand it to him.
(A slight difference is that an ordinary LEAP given to Bob could then be sold on the open market to another person, whereas a granted stock option cannot be. This reduction in liquidity should have some effect on the value at the date of grant. Instead of receiving a $15,000 gift from DDC, Bob has received something less, perhaps only $8, 750, for example. The actual value will be based, I expect, on some variant from Black-Scholes modeling, some statistical analysis of retention rates with various option sizes, etc.)
A more significiant difference is that while a LEAP currently now goes out only a maximum of 2 years (last time I looked), the example above has Bob getting that option for 5 years from the time of grant. According to the usual option pricing models (Black-Scholes, as I mentioned), that option is worth somewhat more than the $1.50 a share for the 2-year LEAP. How much more? B-S gives some answers, but maybe not the full picture.
Anyway, it seems reasonable that a stock option can be given some value AT THE TIME OF GRANT.
Notably, the cost to the company is the cost of buying that same option on the open market. It is NOT the cost of the increasing value of the option as the underlying value of the stock rises.
For example, if DDC goes to $100 then Bob's option to buy 10,000 shares at $10 is worth about $900,000 at about the time he actually exercises it. However, this "in the money" value should not in any way be charged against the company. (Remember, the way to look at it is in terms of the costs they incurred to buy Bob that option on the open market.)
Someone here made a cogent remark recently about the non-liquidity of stock options and their value: if I sell someone the right to buy me existing house at some fixed price, even if that right is not transferrable it is still a thing of value. That is, someone would pay me some amount of money to purchase that right. The exact price would depend on a bunch of the usual things about the expected increase in value of my house, the likelihood that the option purchaser will actually complete the deal, etc.
But if I am paid, say, $5000 for an option I sell to Dorenda to buy my current house for $500,000, then that is _income_ to me. And an _expense_ to Dorenda. And if Dorenda's employer buys that option for _her_, then he has given her a $5000 gift/bonus. And thus the tax code already takes care of how these things are handled (more on this at the end).
Since Bob received a gift from DDC valued at about $8,750 (assuming my calculation above...this will need to be pinned-down carefully) on the date of grant, this should be reported as income by Bob and as an expense by the company.
The same logic should apply to other "fringe benefits" like insurance and medical policies bought by the company and given to the employee. (That they are not is a big problem in our tax code.)
Needless to say, I also support substantial reductions in tax rates and flattening of the rate vs. income curve.
But, to repeat, stock options are an item of value at the time they are granted. To not tax them as items of value (and thus to not have companies treat them as expenses just like other items of value given to employees) is a distortion of the tax code.
What FASB does is not even the most important issue. The IRS should begin taxing options as items of value, at the time of grant. This will cause the necessary accounting changes to happen immediately.
--Tim May |
