As I see it (IMHO), an option grant is equivalent to selling the stock at the current market and collecting the money for the sale at some future date.
If company sells stock at the current market they get money for it in the present. They get to use the money. They don't own the stock since they have sold it. The issued stock contributes to the share count.
If company grants an option at the current market they will get the money when option is exercised. They don't get to use the money until they get it on exercise. They don't own the stock since they have promised it to grantee. The options contribute to the 'fully diluted' share count (which BTW sometimes doesn't involve simply 'counting' the options, but rather a somewhat mystical valuation process).
What's the difference between these two? The end points (state of the world vv company), before grant/sale and after exercise date are the same i.e. that the company had stock before grant/sale date and no money (from the sale) and after exercise date the company has no stock and has money from the market price on grant date. In both cases the number of shares outstanding has increased by the same amount in each case.
For stock sale case the company had use of the money for the option period. For option grant case it did not. The option 'expense' should pay for depriving the company of that use of money. This is an 'easily' calculated number (It's also a part of the option expense valuation methods).
If one wants to add other 'expense' to the option grant case then why should it not be added in the case of a market stock sale at the time of the grant? In either case, the company gives up stock and gets the market value at that time. In either case, the company gives up any possible appreciation or depreciation in value of the stock. But in the option grant case they effectively have to 'borrow' the market price to remain even. The cost of that money should be the option 'expense'.
IMO, deciding that the option itself is 'compensation' to the employee and hence MUST be an expense, is silly since it is (usually) non-negotiable and subject to termination on the employer's whim (via termination of employee). Let it ripen and then find out what it's worth. Sure, it's possible the convert anything to contingent money. I just don't see how it helps understanding the situation.
An extreme example:
Last week Baidu had an IPO at $27. Next day stock hit $150. If they had granted an option on IPO day at the IPO price exercisable the next day, what expense should Baidu record?
Here's my understanding of how it would work out the next day with next day price of $150:
Grantee exercises and pays Baidu $27 and gets the stock. Baidu records a tax reducing loss of $123 (AFAIK, per present IRS regs). Unfortunately, IRS claims that grantee made a profit of $123 instantly and grantee has to pay IRS. (Hope he managed to sell instantly because the stock tanked today).
Gosh. Baidu 'lost' that $123. What option expense should Baidu have booked on the grant date? Today (Tues, 9Aug05) BIDU is at $97. So did Baidu 'lose' only $70? I have no answer.
Whatever the option expense determined, shouldn't the the IPO stock also be expensed, determining the expense in same manner as the option expense, since both were sold at the same price, $27? Of course not. Balance. Income. Capital. etc. etc.
And yet, both events have the same result. Except, of course, the real option 'expense' is the $123 Baidu gets to deduct from taxable income on exercise, not only gaining them the $27 payment for the stock, but also the tax saving for that 'no cost' $123 expense. Real money not turned over to the IRS. Or the Chairman?
I have no idea how GAAP would treat this. AFAIK, IRS would be cool with it.
So if you are profitable and think your IPO is going 'through the roof' but can't get the underwriters to place it, just grant options on IPO day exercisable 'soon' and at least get some of the benefit through tax savings. |
