It seems that my posting privileges have been restored through the efforts of the many friend I have made on SI. I want to thank all of you who have rallied to my support.
I am deeply moved.
Now to my answer to your question:
You raise an interesting question, but I think it really mixes two
issues that are best treated separately.
The first issue is one of accounting. Under current rules stock options given employees are not counted as expense items. The proposed rule change would only include the differential between the value of the options as a cost. I think this is a step in the right direction, but it isn't sufficient. There are really two costs associated with option grants: the first is a dilution of existing equity holders; the second is the ability to buy shares below market value. Let me illustrate with a hypothetical. Suppose we have a company with total assets of $100 MM, no liabilities and 1MM shares of stock o/s. The book value is therefore $100/share. Now suppose that options are exercised allowing employees to purchase 100,000 shares of stock at $25. The total assets of the company rises to $102.5 MM, but the number of shares has also increased so we now have 1.1MM shares o/s. Therefore, the book value per share has decreased to $93.18, and the total cost to pre-existing shareholders was $6.818 MM, but because of the accounting rules there is no cost recorded on the income statement. I have purposely chosen book value as the basis, but the identical argument could be made for market capitalization, eps and other metrics of interest to shareholders.
Regardless of the merits of options as compensation, the accounting
seems designed to fool investors and need to change in my opinion.
The second issue is whether companies should issue these instruments at all. The usual arguments in favor of options are that they allow
companies to hire and retain the talent they need, and that because the options vest slowly they put the employees and the shareholders on the same side. I think both arguments are flawed. If companies paid cash for employees (including performance bonuses) I think there would be no issue about hiring and retaining good people. Furthermore, relying on these instruments creates a false performance base because significant employee costs are eliminated as part of the cost of doing business. The ultimate value of the options also imposes a one size fits all mentality on the recipient because the amount of the profit to the employee depends on the market value of the stock which is a function of the efficiency of the entire organization rather than of the performance of the individual.
I think that the argument that options place employees and shareholders on the same side is equally flawed. If that were the case, why is it that companies such as SEG, PSFT, AMD, and a host of others have decreased the exercise price in spite of the fact that corporate performance was poor? The reason is simple. These instruments are not incentives at all. They are entitlements. And if that argument is not reason enough, consider the rapidity with which most option grants are exercised and the stock immediately sold. I understand that one of the first things that Warren Buffet does on taking over a company is to rid it of employee stock options.
Perhaps I am overly cynical in my view, but I believe that the more transparent the accounting system becomes the better.
TTFN,
CTC |
