Silicon Investor (SI) -- The First Internet Community

STOCKTALK

We've detected that you're using an ad content blocking browser plug-in or feature. Ads provide a critical source of revenue to the continued operation of Silicon Investor. We ask that you disable ad blocking while on Silicon Investor in the best interests of our community. If you are not using an ad blocker but are still receiving this message, make sure your browser's tracking protection is set to the 'standard' level.

Politics : Ask Michael Burke -- Ignore unavailable to you. Want to Upgrade?

To: pater tenebrarum who wrote (82728)	8/8/2000 2:23:27 AM
From: Don Lloyd	Read Replies (2) \| Respond to of 132070

hb - [if i may chime in on the point of view debate re. stock options issuance: the only PoV that counts is that of the shareholders. and in practice, the stock option schemes hurt many corporations as well, as they are trying to offset the dilution by buying back shares and in the process are impairing their balance sheets...see IBM for a good practical example of this....] Your input is more than welcome, but the complexity of the option grant mechanism makes it all the more important that economic reality is accurately recognized. The danger is that ambitious politicians will play on deliberate distortions to make a bad situation worse, as is their wont. I find it hard to imagine that people like Smithers are actually serious in suggesting that the company be required to buy covering options on the open market. Even complete economic ignorance is not a sufficient excuse for such a stance. I suspect that our only practical disagreements are in terms of causes, effects, and remedies. I would be perfectly willing to stipulate that some 90% of the use of employee options is abusive, and that 100% act to mask and distort the presentation of business results. Subject to being convinced otherwise, I will continue to maintain that a corporation and its shareholder owners ARE separate entities, and a given action can impact either one or both. An option grant : 1. dilutes the shareholders. 2.a. effectively eliminates an unmeasurable negative cash flow from the corporation directly and the shareholders indirectly. This is the phantom cash bonus that would be needed on the income statement to produce the same levels of labor market competitiveness and employee retention. 2.b. produces a positive cash flow on the balance sheet only to the corporation directly and the shareholders indirectly. This is a combination of the sale proceeds of employee stock option exercises and the tax deductions allowed for those exercises as if they were compensation expenses. 3. Stock is bought back on an irregular basis, often using as phony justification a perceived need to sterilize the shareholder dilution above. This is a negative cash flow for both the corporation directly and the shareholder indirectly. It is also anti-dilutive for the shareholders. The fiduciary responsibility of the management to the shareholders SHOULD require that EVERY dollar should be invested for its highest available risk-adjusted return. The irrational tendency of the market to reward even a mention of a stock buyback tends to encourage management to execute buybacks even when they are contra-indicated on an investment basis. The combination of all of the above can clearly be either net positive or net negative for either the corporation or the shareholders or both. It is, or at least should be, the responsibility of management to modulate/moderate its option grant operations and stock buybacks separately so as to optimize the net impact on shareholders (as opposed to the corporation when the two are in conflict). I believe that most of the confusion and the STRANGE proposed remedies result from serious economic misconceptions arising from an ignorance of Austrian Economic Theory. In the first place, per AET, all costs are opportunity costs. The corporation accounting entity has a zero opportunity cost for dilution because it can continually dilute without limit from its own POV by simply creating new shares or the option grants for same. The actual limit must be supplied by the fiduciary responsibility of management to the diluted shareholders as noted above. Secondly, there is a misconception that the fact that the recipient of an option grant receives something of real and perceived positive value, both at the time of grant and at the time of exercise, necessarily means that the granting corporation suffers a corresponding cost. This is essentially a mistaken belief that there is such a thing as intrinsic and objective value, and implies that a mutual exchange economy is a near-zero sum game as it is also believed that an exchange sets an equality of value on the goods exchanged. Per AET, all values are subjective (including both preferences and actual environmental context), and all mutual exchanges result from the bilateral and conflicting perceptions by both parties that the value of the goods or services received exceed the value of those supplied. Even more strongly, an actual exchange that is made is perceived to be the one that has the greatest positive discrepancy in perceived value between goods received and goods expended among all the possible alternative exchanges. Also, the subjective nature of value precludes any possibility of comparing the perceived value of a good to one party to the perceived cost of the same good to the other party. To summarize all this, the existence of a received value by one party says absolutely NOTHING about the perceived values or cost impacts to the other party. The issue of tax deductions is very strange. AFAIK, the tax deductions are positive cash flows that add to cash on the balance sheet, but do not appear on the income statement, nor (and this is only a belief) do they affect the effective tax rate used on the income statement. The cash is real, and the management's fiduciary responsibility to the shareholders must include its positive effect and plan to qualify for it. On its own, it appears to be a rather unjustified gift from the IRS to the corporation. Actually, this is not the case for two reasons. First, the employees end up effectively paying the tax themselves. Secondly, the very idea of a corporate income tax is ill-advised and counter-productive. As the cliche goes, 'corporations don't pay taxes, people do'. In actual fact the tax is incident on consumers in increased product prices, on workers as their wages are reduced in concert with their lowered net marginal products, and on shareholders with their reduced net profits. The market and the investors themselves cannot escape a significant part of the blame. The willingness to reward buybacks even as they see shareholder funds being expended in gross quantities tends to increase the part of a company's value that is tied up in market psychology and reduce the part that has real financial content behind it. Also, the market and investors tend to be incredibly lazy and simplistic as they want to reduce a company's value to a single number, the EPS. When evaluating dilution, it really should be the annual rate of dilution that should be considered, not the total dilution unless a liquidation or buyout is contemplated. A company that restricts its option grants so that its annual rate of dilution (without buybacks)is only a small percentage of its revenue and earnings growth rates should not be subject to criticism. However, its buyback decisions must be independently made on the basis of projected rate of return on each dollar expended, and not in response to dilution. Regards, Don