Those pesky stock options... The real price, once again.
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Wednesday July 4 11:28 AM ET
Column: Hidden Costs of Tech Stock Options
By Andrea Orr
PALO ALTO (Reuters) - Would investors have shown quite so much interest in a company had they known that the $10 million profit it reported last year should have been only $4 million?
Would they have bought shares in a small technology startup that said it earned a few hundred thousand dollars, but was really, by stricter accounting standards, still in the red?
And what about an Internet business that earned the distinction of being consistently profitable while many of its peers were racking up losses? What if it turned out that the company had never shown an actual profit?
For many of the people who invested in high-tech companies last year, these are not rhetorical questions. Virtually all these companies gave stock options to a large number, if not all, of their employees. Yet, virtually none of them expensed these options on their income statements.
It has long been recognized that stock options, which companies do not have to account for the way they do cash salaries, probably increase earnings, to some degree.
To what degree was never clear until last month, when Merrill Lynch took a closer look at 37 major high-tech and Internet companies, including Amazon.com Inc. (NasdaqNM:AMZN - news), Microsoft Corp. (NasdaqNM:MSFT - news) and Hewlett-Packard Co(NYSE:HWP - news).
YAHOO BENEFITED THE MOST
The Merrill study found that if these companies had expensed all the stock options they gave their employees, their year 2000 earnings, on average, would have been some 60 percent lower than reported. That average does not include the Internet media company Yahoo! Inc (NasdaqNM:YHOO - news), noted in more prosperous times for turning more than a few employees into millionaires with stock options.
Merrill said that Yahoo's earnings last year were some 1,887 percent higher than they would have been had it included the stock option expense.
``It is highly unlikely that Yahoo would have ever reported a profit had they been required to expense stock options,'' said Gary Schieneman, who conducted the study for Merrill Lynch, before leaving to join the Financial Accounting Standards Board (FASB).
Many other companies, including eBay Inc. (NasdaqNM:EBAY - news), Exodus Communications Inc. (NasdaqNM:EXDS - news) and Juniper Networks Inc. (NasdaqNM:JNPR - news), saw earnings benefits of more than 100 percent from excluding some business expenses, primarily stock options, from their results.
Most of them declined to discuss the stock option benefit. Yahoo said only that it follows standard accounting procedures.
And it does.
To be clear, companies are not required to include the stock option expense in their earnings, other than in footnotes that appear at the very end of the report and are often overlooked by investors.
Still, many accountants think that the practice is less than forthcoming. After a year of unprecedented interest in high-tech stocks, one can only wonder whether the investor stampede would have been quite so strong had corporate earnings been considerably lower.
TECH COMPANIES FIGHT TO KEEP THE OLD RULES
``Many companies claim stock options are not really an expense since they are not transferring actual cash,'' said Jeff Mahoney, a project manager at the Financial Accounting Standards Board in Washington, DC.
``We argue that it is compensation. Whether it is cash or toothpicks, there is value being transferred.''
Since most companies from traditional industries like car or consumer goods manufacturers issue stock options only to certain top managers, accounting for these options has not always been a big issue.
But as more Silicon Valley companies started to grant options to even the lowest ranking employees, FASB, which sets accounting standards, has considered changing the rules. There is a compelling argument in favor of doing so, since workers would probably demand higher salaries if options were not part of the compensation package.
But FASB said that each time it has proposed new rules, the objections from companies have been overwhelming.
``The last time we issued a proposal, we received over 1,000 letters, and almost every one said that we shouldn't change the rules,'' said FASB's Mahoney.
``If you talk to most analysts and investors, they believe all stock options ought to be shown as a compensation expense, but every letter we got objected to doing that,'' he said.
Steve Milunovich, the Merrill Lynch analyst who issued the report and reignited the debate, pointed out that there are some reasonable arguments for letting existing policies stand.
More than many businesses, high-tech company assets are heavy on ``intangible'' things, such as intellectual property, that are not always fully reflected in income statements. The stock option benefit may help to offset the costs companies inadvertently show by not being able to account for all their intangibles.
Still, he said the stock option impact is a ``big deal,'' that can further cloud a company's true performance. |
