Les -
Thanks for the target. -g-
nationalpost.com
Dear Diane,
Your article on stock options certainly passionately expresses the common
view of corporate stock options, and there is no doubt that every corporate
function is subject to potential abuse and malfeasance, but unfortunately,
your sources have led you into error virtually across the board.
From your article -
"...One argument against accounting for option profits as expenses against
profits is that the options have no value when issued.
That's bunk.
As Warren Buffet, the U.S. investment guru and critic of options, has said:
"If options aren't a form of compensation, what are they? If compensation
isn't an expense, what is it? And if expenses shouldn't go into the
calculation of earnings, where in the world should they go?"..."
First of all, you misstate the argument. It is not that options have no
value when issued, but rather that the value is unknown and depends on the
future price trajectory of the stock.
Secondly, as Mr. Buffet should be expected to know, a stock option is a form
of compensation that is effectively a contingent offer of partnership, and
not an expense. To prove this, I formed a synthetic company with real assets
that could be exactly valued at any time, and then compared the results of
salary compensation with stock grant compensation (a limit case of option
grants). The result was that the two cases produced identical results for
everyone, with the salary costs being effectively paid by the shareholders
in all cases. In the case of salary compensation, every paycheck cut
represents a cash loss to the shareholders. In the case of stock
compensation, every share granted dilutes the original shareholder's stake
in the company. By simply increasing the share count to reflect the
dilution, the net cost to the shareholder is exactly identical between the
two cases. The obvious implication of this is that any attempt to add a new
pseudo-expense line to the income statement will result in a double-counting
of the negative impact in shareholder value due to employee compensation.
Contrary to the belief that employee stock options are a form of theft,
corporate management would be violating its fiduciary responsibility were it
to fail to maximize shareholder value by issuing stock options WHERE AND TO
THE DEGREE APPROPRIATE, under a shareholder approved plan.
Stock option plans produce a number of real positive cash flows to the
company, and thus to the shareholders. These include a) cash compensation
reduction, b) option exercise payments, and c) compensation tax credits.
While it is true that the mix of cash compensation and option grant
compensation make corporate and business comparisons between different
companies difficult, it certainly does not justify double-counting of
expenses. It needs to be noted that the purpose of accounting is NOT to
simplify the computer scanning of the income statements of different
companies for direct comparison. Rather, accounting is a service paid for by
existing stockholders in order to prevent fraud and to illuminate the
quality of business execution, on an individual company by company basis.
It is NOT the granting of stock options that is the primary malfeasance of
corporate management, but rather the expenditure of shareholder funds to buy
back company shares independent of stock price and value.
Just to further indict your sources, consider the following quote -
"..."The true cost to the company of a stock option is the difference
between the amount received by the company when the employee eventually
exercises the option and the greater amount that the company would have
received if it had issued the shares at the market price at that time [of
exercise]," it said. "And the value received by the employee is, not
surprisingly, equal to the cost to the company."..."
Unfortunately, this paragraph, as reasonable as it sounds, is pure economic
nonsense.
First, economic costs are opportunity costs. Since there is no limit to how
many shares can be issued with shareholder approval, the option grant and
exercise does not preclude the company from ANY economic activity, including
the selling of new shares on the market. Thus option grants and exercise
have zero opportunity cost to the company. As noted above, all of the cost
is directly incident on the existing shareholders in the form of dilution.
To further make this point, from the point of view of a non-shareholder who
might want to buy the entire company, the distribution of ownership is
entirely irrelevant to the price to be paid. If the management decides to
give away new shares to every other passerby in Times Square on Saturday
afternoon, the value of the entire company to the potential buyer is
entirely unaffected, although existing shareholders are diluted.
Secondly, the value received by the employee is NOT equal to the cost to
the company, and, in fact, the two need have no relationship at all. All
economic values are subjective and all voluntary transactions result
precisely because each party values the good or service to be received
greater than the good or service to be supplied.
Regards,
Don Lloyd
Peabody, MA, USA |
