Paul,
The latest issue of Forbes raises the question of employee stock options and their potential diluting impact on future earnings. I would like to hear your take on this issue.
Forbes cites a study suggesting that if the largest 100 U.S. Co's had charged the costs of their options to their income statements, their reported 1995 earnings would have been about 30% lower. The study also found that 11 of these 100 co's, one of them Dell, would have shown a loss in 1996. Dell's 1996 earnings which were reported as $498m, would have been a $862m loss had they been adjusted for employee options, according to the study.
Although I'm not an accountant, it seems to me the study makes a glaring error. I believe Dell fully hedges itself, either with call options purchases or repurchasing shares of stock in the market, when it grants employee options. In computing Dell's $862m loss, the study very likely failed to recognize the enormous unreported "profits" Dell has earned on its hedge positions. Consequently, the $892m loss figure may be completely off base.
Nonetheless, shouldn't the COSTS of the share buybacks and options hedges be deducted against earnings as an employee expense? Forbes and others who raise this issue seem to have a legitimate point that earnings of firms like Dell are being overstated.
I have 2 questions:
1. Do you think the stock market sees through the accounting distortions generated by employee options, and is properly discounting stock prices based on expected cash flow rather than reported earnings?
2. If firms were required to report the costs of their options programs against reported income, what would happen to their taxes? |
