b) Options *are not* a business expense !
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The politically correct solution to book and report the BLACK SCHOLES MODEL derived "STOCK OPTION GRANT EXPENSE" DOES NOT correspond to company cash flows related to stock options, and, it is not applicable to valuation of non-transferable non-tradable employee stock options - IT IS WRONG, MISLEADS INVESTORS, and it DOUBLE COUNTS DILUTIVE IMPACTS to the extent average shares include potential future dilution from exercisable options.
Issuance of shares upon exercise of employee stock options has the following dilution impacts:
·The new shares dilute earnings per share, not absolute earnings itself. They do this by spreading absolute period net income over the greater number of average outstanding
shares.
·Also, the new shares dilute dividends per share. They do this by spreading the absolute period dividend amount over the greater number of average outstanding shares.
·Finally, the new shares dilute book value per share. They do this by spreading the absolute net book value amount over the greater number of period ending outstanding
shares.
Currently, FASB Standard 128 "Computing Earnings Per Share" only requires disclosure of potential FUTURE DILUTION from "in-the-money" outstanding employee stock options. BOTH
Standard 128 and APB Opinion No 25 ARE SILENT ABOUT measuring the PAST DILUTION IMPACT FROM SHARES ISSUED for PAST EXERCISED employee STOCK OPTIONS, despite the obvious fact that such share issuances have been caused dilution of earnings, dividends, and book value per share to company shareholders.
IMHO, the best solution would require NEW DISCLOSURE RULES THAT WOULD ENABLE analysts and company shareholders TO MEASURE TOTAL DILUTION (Past and Potential Future) from employee stock option plans.
The additional information needed to measure such total dilution would be a REQUIRED DISCLOSURE in the footnotes to financial statements. The disclosure would at minimum
include the following:
·Average Outstanding Shares and Period Ending Outstanding Shares, EXCLUDING and INCLUDING to date share issuances related to exercised employee stock options.
·Also, there should be required a discussion disclosing the above dilution impacts (item-by-item for each period financial statements are presented) and how dilution
calculations for each item were made.
However the Financial Accounting Standards Board ultimately decides to rule on accounting and reporting for what they refer to as "stock option expense", and, no matter how such amount is calculated; such "expense" will be put back into "Cash Generated from Operations" on the Cash Flow Statement. That's because the issuance and exercise of stock options by employees DOES NOT RESULT IN CASH OR ASSETS LEAVING THE COMPANY - therefore it can't be an expense of the company just as the amount I pay for my personal home heating oil bill can't be an expense of the company. Instead, shareholders buying company employee shares bought under option plans pay cash directly to the employee at the market price at date of share resale. Those resale proceeds include the enormous profits such employees make on reselling such shares. FOLLOW THE CASH and YOU SHALL BE ENLIGHTENED. Stock options are a direct expense of such shareholders (like their personal Mastercard bill). Companies correctly do not consolidate into their financial statements the personal income and expenses of their employees.
IMHO from the corporate executive's viewpoint, issuing stock options is a very devious way to reach directly into the wallets of company shareholders without negatively impacting company cash - especially when such issuances are excessive.
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O.K. - Now send me my free CSCO shares <grn>
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