Accounting Cops Delay Change
FASB, in Stock-Options Battle,
Says Companies Will Receive
Six Additional Months to Adapt
By JONATHAN WEIL, SUSANNE CRAIG and THEO FRANCIS
Staff Reporters of THE WALL STREET JOURNAL
October 14, 2004
Bowing to pressure from securities regulators and corporate executives, the organization that sets the nation's accounting standards announced a six-month delay in its long-awaited plan to require companies to treat employee stock-option compensation as an expense that counts against earnings.
The move involving companies' financial statements alarmed some supporters of the proposed change. They said they fear that the delay will give high-technology companies -- among the biggest issuers of stock options -- additional time to build support for federal legislation blocking the plan for good.
Under yesterday's decision by the Financial Accounting Standards Board, based in Norwalk, Conn., mandatory expensing of stock-option pay would begin during the third quarter of 2005 for companies with calendar fiscal years, rather than the first quarter as the board originally had proposed in March.
Stock options, which are corporate perks that grant an employee the right to buy stock at a fixed price during a specified period, became a source of immense wealth during the 1990s stock-market boom, especially for top executives. The current rules give companies the choice of leaving stock-option pay off their income statements, relegated to footnotes in their financial reports. That is in contrast to the treatment for cash pay and other benefits. That special treatment, some critics say, has encouraged outsize options packages to senior executives, creating an incentive for them to play accounting games to give their stock prices quick pops.
The latest development in the accounting battle comes as many companies are favoring other forms of stock compensation, most notably so-called restricted stock, even as they continue to issue stock options. While stock options give the employee the right to buy a share at a set price, restricted shares are given to an employee but can't be sold for a designated period. Restricted shares have become popular with many employees because they, unlike stock options, retain some value even if the stock price falls sharply.
On Wall Street, as much as 90% of annual compensation can come in the form of stock-heavy bonuses. This year, bonuses on the Street are expected to be up as much as 10% to 20% over last year, thanks to an improved profit picture.
Securities firm Lehman Brothers Holdings Inc. widely is considered the biggest issuer of restricted stock, with every employee getting at least some. It pays as much 40% of compensation in stock to its top executives, now primarily restricted-stock units. Today, about 30% of the firm is employee-owned, up from just 4% a decade ago.
A survey released this week by Frederic W. Cooke & Co., a research firm that tracks trends in executive compensation, found that more than half of the largest 250 companies in the Standard & Poor's 500-stock Index already award restricted stock. Many of these same companies voluntarily have moved to expense the options they also issue.
So far, Microsoft Corp., whose lavish use of stock options over the past two decades made millionaires of thousands of its employees, is probably the highest-profile user of restricted stock or its variants. Across the nation, Wall Street firms have been some of the biggest fans of restricted stock and are expected to rely on it heavily when they dispense annual bonuses in coming weeks.
In recent weeks, Securities and Exchange Commission officials have pressed the FASB to consider a delay in the new rules, on the grounds that companies and auditors already may be overloaded trying to comply with other regulations that take effect this year under the landmark Sarbanes-Oxley legislation on corporate governance.
Yesterday's move also follows a flurry of letters by more than 50 senators to SEC Chairman William Donaldson, urging him to press for a delay.
In an interview, FASB Chairman Robert Herz said the board decided to delay the requirement in hopes of striking a balance between companies' concerns and the needs of investors who want stock-option expenses recognized as soon as possible. "The most important thing was that we heard, not only from a lot of companies and auditors but also the SEC staff, that people are going to be very busy and consumed in the first quarter and that, if at all possible, we should give some them relief," he said.
Still, the board's move drew criticism from both advocates and opponents of the accounting change. Supporters of expensing said they feared the delay may play into the hands of the proposal's opponents. Lynn Turner, a former SEC chief accountant, said the delay "raises the specter that, depending on how the election turns out, Congress will push for even further changes after the first of the year."
Several Silicon Valley companies, whose ability to show growing profitability is threatened by the standard, have been hammering on the FASB's methods for measuring the value of stock-option expenses. Like most measurements in accounting, these methods will yield mere estimates. Opponents also criticized a separate decision by the FASB yesterday to reject a valuation technique recommended by Cisco Systems Inc., QualcommInc. and Genentech Inc., which generally would produce lower expenses than the models proposed by the FASB.
"Nothing has changed," Cisco spokesman John Earnhardt said. "The FASB still has not addressed the flawed valuation model."
The FASB's success or failure at mandating option expensing widely is viewed as a crucial test of the board's ability to survive as an independent, private-sector regulator. Mr. Donaldson, the SEC chairman, has urged Congress not to intervene in the matter. In July, the House passed a bill that would block the FASB's standard and replace it with a law requiring companies to count only their top five executives' stock options as an expense. The bill faces an uncertain future in the Senate.
On Wall Street, executives get a blend of options and restricted shares. Goldman Sachs Group Inc. Chairman and Chief Executive Henry M. Paulson Jr. was awarded $21 million in 2003 -- all but $600,000 in restricted shares. Merrill Lynch & Co.'s top boss, E. Stanley O'Neal, received 39% of his $28.1 million in 2003 total compensation in restricted stock, up from 32% of smaller total compensation the year before.
In contrast to stock options, the cost of restricted stock is booked as the shares "vest," meaning the employee has the right to keep the shares even after leaving the company. At Lehman, as much as three quarters of an award typically vests after at least two years, at which point Lehman must have expensed that portion of the award. The remainder often vests over the next three years, and Lehman books the expense during that time.
The programs aren't without their drawbacks: Typically, companies buy back shares down the road to offset the dilution that comes from giving heavy slugs of stock to employees. "The share program, as one substitute for cash, is aimed at getting employees to think like shareholders," said Lehman Chief Executive and Chairman Richard Fuld. "One of the issues with the program is that the cost of it goes up as the stock price goes up, but that is good problem and one I can live with." Lehman shares are up more than 160% over the past five years.
Lehman bought back about $1.51 billion in stock in 2003, and over the past five years has bought back $6.2 billion. Lehman said that cost is offset by tax deductions and cash received by the company when employees exercise their stock options. It said the actual cost to Lehman was $43 million in 2003, and $968 million over the past five years.
Write to Jonathan Weil at jonathan.weil@wsj.com, Susanne Craig at susanne.craig@wsj.com and Theo Francis at theo.francis@wsj.com
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