Chuzz,I am sorry if I have misled you on the use of terms.
I was referring to "EPS on diluted basis". That is earnings per diluted shares, not just "earnings" as has been mistaken by you. You are correct that the earnings are not affected on paper. However, let's admit that stock options granted to employees has been one of the most powerful alternative long-term incentives that can drive a high-tech and/or new start companies to great success.
When options are exercised and shares sold, the net effect is more shares outstanding so those cash-rich companies are constantly buying back from the market (mostly at market price) to offset the increase so as to maintain relatively constant divisors for EPS reporting. I had expressed my concern about DELL as they repurchased much more than they issued through the options program thus inflating the EPS growth, say from 58% to 65% in the last Q simply by reducing the divisor thru the repurchase. It is okay as long as they continue to generate the kind of cash to sustain such purchase.
The concept of using stock option as a long-term incentive is still sound. It may appear as a takeaway from shareholders on the face of it. However, this new form of alternate compensation has paid off big time. Look at all the successful high tech companies. They all grant options to all employees, not just the top management.
Most employee stock options are granted at market price on date of grant. Some are premium-priced, that is at a higher (10-15%) price than market. Very few would grant at discount because that will attract income tax for the optionee at grant. The employee has to pay tax on the discount, except in the case of employee stock purchase program constructed under the tax code 423 - anther popular stock program to connect employee to "ownership" for increased productivity. Most companies offer this program to employees who participate on a voluntary basis. Employees can purchase the company stock at a 15% discount through payroll deduction with a ceiling of up to 10-15% of pay, and a total value of $25000 per year (as allowed by the IRS).
Stock options normally do not vest immediately upon grant. The most popular vesting schedule is 20% per year. For example, if you are granted 100 shares today, only 20 shares become vested on the anniversary date next year. They typically will have a 5 year validity. This is why I say it is an excellent retention tool. Look at how many options there are at stake if the company has an annual grant. If the employee leaves, all options whether vested or not, will be forfeited. He or she will have to start all over again in the new company. The drawback of this program is when the stock price persistently perform under the option price, we call them "underwater options". That can be very demotivating. Repricing is like starting it all over again. Employees would want to "start all over again" in a familiar environment than doing in a new company.
I do not agree with your statement that management use this method to hide the cost and steal from shareholder. The FASB rule 123 requires that proforma cost of options granted being reported as footnote on the annual report so you can go to that section to find that cost element. It cannot be reported as actual cost because it is not. If reported, the IRS will add it back for corporate tax purposes anyway.
What I would advocate is that, instead of reporting the cost at grant (which is hypothetical anyway) it should be reported when options were exercised and shares repurchased. The tax credit currently allowed the company on the spread should only be granted if the company actually bought the shares back from market and that cost reported in the P&L for the period the company bought those shares. This will be clean and our debate will not be necessary.
Humbly submitted,
RT |
