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Strategies & Market Trends : Good Investment Theses: VALUATIONS w/ FUNDAMENTAL ANALYSIS
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To: Edwarda who wrote (138)5/6/1999 11:45:00 AM
From: Chuzzlewit   of 160
 
Edwarda, I'm not sure of what you are saying, so I am going to take this opportunity to recap all of my objections to ESO's.

1. ESOs violate the economic reason for issuing capital stock: a company ought to sell stock only because it needs the cash for running the business.

2. ESOs violate the basis for accrual accounting because the cost of ESOs is not included on the income statement. Hence, earnings are overstated, and the extremely poor transparency of ESO transactions makes it very difficult to calculate the implied cost of labor.

3. ESOs are poor mechanisms for rewarding performance because they do not distinguish the stellar performer from the mediocre. Further. the value depends on the stock market, and markets are unpredictable, and this often results in repricing. In effect, ESOs are entitlements, not performance bonuses.

4. ESOs make little financial sense. The differential in income tax rates between the tax shield afforded a company for cash payment and the LT capital gains rate is expensive to shareholders.

5. ESOs create an environment for continuing shareholder dilution.

I contend that the reason that most companies engage in ESOs is precise because the accounting is difficult, if not impossible to cut through. That means that management -and they are the prime beneficiaries of ESOs- can continue to rape shareholders without the shareholders figuring it out. I agree with Christopher in one case -- the case where a small, undercapitalized startup needs to ration cash. On the other hand, it is very difficult to rationalize Microsoft's use of ESOs.

TTFN,
CTC
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