That's a good suggestion.
Nobody cares what the value of an option was when granted; the issue is how much
each option is costing shareholders now. Why not alter FAS 123 to adjust the cost of
options for actual changes in the underlying price of the stock? Potential dilution,
option costs, everything changes dynamically with the price of the stock, and could
easily be calculated as part of FAS 123 procedures.
I hope that FASB modifies SFAS 123 in the future based on your input. FASB wanted to
do it your way in the first place, but executives unanimously opposed it because
they wanted to hide the true cost of stock options.
The problem with including updates based on actuals in a modified FAS 123 is that
it would wreck accounting havoc, not that it would be difficult or less meaningful.
Suppose WIND issues options on one million shares at a strike price of $35, then quickly
jumps three-fold on the market's realization I2O really is becoming a standard for I/O.
The value of the options will have increased by more than $70 million, which would almost
double operational costs for the year if the actual cost of stock options were included,
yielding a huge paper loss. This makes no sense to anyone, including accountants at the
FASB, even though in this case employee compensation really would be astronomical.
That makes plenty of sense and has already occurred. The options that Wind River granted
4 years ago are exercisable today and the stock price has more than tripled. This isn't
merely a "huge paper loss" - it's real. The company seems happy to book revenues for
products developed 4 years ago, but doesn't appear nearly as enthusiastic about
recognizing the expenses associated with meeting their option liabilities. Honest
accounting would reveal that the companies hasn't earned any money at all for several
years despite a huge increase in revenues.
So the FASB sidesteps this reality by recommending that Black-Scholes be applied
statically, knowing that results will thereby always appear to be within the realm of
reason.
FASB compromised with executives who wanted an evenly distributed reporting of expenses.
If FASB adopted your suggestion (and mine), they'd be forced to admit each quarter how
many shares were exercised and quarterly results would vary widely. If the amount was
higher than usual, shareholders would know that the employees in the aggregate are
bearish about the future of the stock price. In addition, the company wouldn't be able
to give accurate earnings guidance because they'd be unable to predict the amount of
options employees would choose to exercise during the quarter.
Let's calculate the real cost of the stock options of the CFOs of similar size software
companies based on today's prices using time = 3.5 years remaining, interest rate = 8%,
and volatility = 30%.
Company CFO Current Price Exercise Price # Options Value
Wind River Kraber 37 ¬ 38 30,000 $368,955
Wind River Kraber 37 ¬ 41 70,000 $774,328
RadiSys Turner 20 38 15,000 $ 30,948
Integrated Systems Smith 17 ¬ 10 80,000 $790,995
Phoenix Riopel 12 12 35,000 $142,371
If the price of Wind River was 32 1/4, the value of Kraber's 100,000 options would be
$793,797, which is about about the same as Smith of Integrated Systems - his closest
peer. The Black-Scholes formula is telling us that Wind River is overpriced relative
to ISI or that Kraber is overpaid compared to Smith.
The really sad thing is that RadiSys earns more than the other 3 companies combined
when you acknowledge that options are a compensation expense. And Turner earns much
less than the others! |
