John et al,
Indeed, most accountants are agreed that stock options represent a wage expense, and the knowledgeable debate centers not on whether or not this is a legitimate expense, but the magnitude of the expense.
Just about everybody arguing from a point of rational impartiality agrees that "zero" is not the right answer.
You've largely mischaracterized the area of disagreement, although there are opponents of option expensing who erroneously think the magnitude of the expense is central to the argument.
1. Everyone agrees, or should agree, that stock or option grants ARE a compensation expense.
2. The entire argument revolves around exactly who pays that expense and how it should be recorded.
3. The supporters of option expensing say that it is the company that pays, or is at least responsible for, the expense and that it must appear on the P&L statement in such a way as to reduce reported profits or increase reported losses, as may be.
4. The opponents of option expensing say that it is the shareholders that pay through a dilution of their company ownership share. If we look at the situation immediately after a new share grant, for example, the existing shareholders have the same absolute number of shares, but some of their percentage ownership is now held by the employees in the form of their new shares. If this is completely disclosed, in a footnote or by some other method (not on the P&L) nothing is being held back from the shareholders. If it is desired to do so, there can be an additional disclosure that calculates the dollar amount of the injury to the shareholders by simply taking the number of dollars required for shareholders of their own money to expend on the purchase of the shares needed to restore their previous percentage positions in the ownership of the company.
Which method of recording the compensation expense wouldn't be of any consequence if no one ever used the reports for anything.
The supporters of option expensing apparently want the compensation expense to appear directly on the P&L report, while opponents would say that a full footnote report is not only sufficient but that it avoids other undesired consequences described below.
It seems to me that one legitimate use of the P&L statement is to help distinguish a viable company from a non-viable one. To do this we simply assume that the current P&L report will be replicated into the indefinite future. In this case, a viable company would be one that shows a positive or zero profit and a non-viable company would be one that shows a positive loss.
Assume a company that shows a $10M annual positive profit when stock and option grants are NOT expensed on the P&L statement. Also assume that the same company shows a $10M positive loss when the stock and option grants ARE expensed on the P&L statement. In other words, when the compensation expense is recorded on the P&L statement, it is a $20M expense.
Clearly, the choice of how the expense is reported is also the choice between an apparently viable company as seen from the P&L statement, and one that is not.
Since both supporters and opponents of stock and option expensing agree that the compensation is not a cash expense, the company, if it takes no action to the contrary, will see its bank account increase by $10M each and every year independent of whether it chooses to expense stock and options on the P&L statement or not.
This is a viable business, taking in more cash than it expends, but whether it is a desirable company for its shareholders is a different kettle of fish.
If instead of a $20M employee compensation expense being recorded on the P&L statement, there were a $20M cash transportation expense, there would be no question of company viability as it would pay out more than it takes in every year.
A company that shows an annual loss of $10M on its P&L statement, no matter from where its expenses come from,
would be expected to eventually run out money completely, depending on how much money it started with.
However, this is not true for the non-cash compensation expense, as it adds money every year.
From the view of the shareholder, even though the company adds cash every year, the high rate of his dilution from new shares may well mean that his share of the company is actually worth less year after year.
However, and this is the key point, the shareholder's value of the company can NEVER be reduced to zero by dilution.
This is entirely at odds with the P&L statement containing stock and option compensation expensing as some year must come along in which the value of the company apparently passes from a positive into a negative value region both for itself and for its shareholders, and continues to become more and more negative year after year.
Only at most one of the two methods of expensing stock and option grants can be valid, as they give P&L statements that are completely in conflict in terms of valuing either the total company or an individual shareholder's holding over time.
You can say that you don't care whether the P&L statements give any indication as to the actual viability of a company, or whether it distorts shareholder value over time, but that seems to be farfetched.
Regards, Don |
