Mike:
There is another aspect to Microsoft's use of options that I suspect that company's CFO would just as soon we not explore. I also think it is why they wish to be seen as being so "honest and forthright" about their option liabilities. Herewith a quick explanation.
Employee gets options. Employee's salary is lower than what he would have received if compensation was exclusively salary. Employee happy,...capital gains tax lower and MSFT's stock always goes up. Company happy because it now benefits from a reduced expense line, which artificially boosts profits.
OK, so far, nothing new here. So lets move forward a bit.
Employee exercises option, and of course at a delightful profit. The employee now has an immediate tax liability which is the capital gains tax owing on the gain. Employee happily pays Uncle Sam.
Again, nothing new, so let's take it one more step.
MSFT now applies to government for a tax rebate. The rebate is equal to the sum paid by the employee in capital gains tax. At year end, MSFT deducts the whole sum, thus benefiting its bottom line enormously. Remember, there was no cost whatsoever incurred by MSFT to reap this benefit,...no cap ex, no cash, no labour, no risk. NO COST AT ALL. We are talking hundreds of millions of dollars in benefit. We are additionally talking sums that more than just "significantly" jazz up MSFT's bottom line.
How can this be? Why does this money flow back to the company?
Believe it or not, the company gets this back under the heading of "compensation expense". I love the irony,... the company "retrieves" money for a "compensation expense" that never appeared on the expense line. In fact, the company gets it back for having been bright enough to hoodwink its shareholders, who actually pay the bill on this through dilution.
Why does the government not complain or close this gaping loophole? Because, for the short term, it is receiving a ton of dough from capital gains tax. It also gains because of all the trading that is going on (not capital gains). The turnover of stock these days is enormous, and on every trade, the government takes its cut. I have no doubt that as soon as this market crashes, it will close this crazy thing off in a nano-second.
(In passing, corporate taxes, which always have paralleled corporate reported earnings, no longer come close,...a clear indication as to how bogus the reported earnings are. The IRS is swimming in tax receipts that are market related).
Back to MSFT for the wrap-up. The company knows that so long as the stock continues to appreciate, it benefits in several ways.
- Options will be exercised, bringing in beaucoup de cash, without any financing costs. No wonder they issue them to the lawn boys.
- Options keep the salary line down, which bolsters the bottom line.
- As options are exercised, hundreds of millions of dollars flow back to the company from the tax benefit. The public is unaware, so the company's "earnings" look better. These are "super dollars' as there is minimal cost involved,...right to the bottom line.
- All that is required to keep the whole scheme airborne is a stock buyback program so that the stock price can be "assisted" as needed.
- The stock buyback program provides its own benefit, it that an additional hundreds of millions of dollars can be acquired through the sale of put options. These are also "super dollars" (no expense) that benefit the company's bottom li,.....ooops, sorry, an accounting nicety here,...the company's cash flow.
Who loses? Shareholders, through dilution,...a double dose of dilution,...once through the employee options and again through the share buy-backs. Of course they don't care so long as the stock price is rising and they are not the unfortunates who get left holding the soggy bag.
There's even more to this story but the above provides a bit of understanding. Most would have a fit if they were aware of just how big this whole house of cards is. Hello Arthur Levitt.
Incidentally, our own Lucretius Taurus posted info on this in December on this thread. If I remember, it related to comments from Bill Parish
Best, Earlie |
