OT ... Kirk, re "Options are an expense that is paid by the shareholders in the form of dilution."
The old double counting argument. It keeps popping up like a new cork, even though it's quite old. Rather than cite others, let me present the argument that finally convinced me -- that BOTH dilution and expensing are required.
You and I each own 50% of a going concern, with 490 shares each. We grant 1 option, with an exercise price of $33 when the stock price is $33, to each of our 20 employees.
Let's speed up the entire option life cycle by assuming no vesting requirement -- these options are exercisable immediately -- and that the stock price jumps to $50 the very next day. Let's further assume all employees exercise at that $50 price.
We both decide we would still like to own 50% of the company, so we each buy 10 of those shares for $500 out of each of our pockets. Our employees pocket $17 each ($50 - $33) for a total of $340.
Before the grant and exercise, there were 980 shares outstanding of which you and I each owned 50%. After, there are 1000 shares outstanding and we each still own 50%. Obviously, net income must be now divided by 1000 shares, instead of 980. That's the dilution -- with which you apparently agree.
As a result of the exercise, shareholders' equity has increased by $660 (20 * $33). We're the owners, so we declare a $0.66 per share dividend. You and I both pocket $330 (500 * $0.66), reducing our cost to maintain 50% ownership to $170 each ($500 - $330).
In summary, we've got a $340 total less in our pockets, and the employees have a $340 total more in theirs. We each owned 50% of the company before, and we still own 50%. The company is worth exactly the same after as before .. but there's been a $340 transfer of wealth from shareholders to employees. That's the expense. The fact that you and I paid the expense makes no difference. Effectively, we paid that expense on behalf of the company .. and it is compensation income to the employees.
This sequence of events does not involve a shell game. It is real .. and hopefully, you now see that *both* option expensing and dilution are required fairly treat the overall consequences of the events.
Regards, Ron |
