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Non-Tech : The ENRON Scandal -- Ignore unavailable to you. Want to Upgrade?

To: PartyTime who wrote (2042)	2/1/2002 3:37:00 AM
From: Baldur Fjvlnisson	Respond to of 5185

Funny Money 101: There's no accounting for stock options. Well, almost none. By David Futrelle NEW YORK (CNN/Money) - They are the questions every investor can't help but ask themselves: Is there an Enron -- or two, or ten -- in my portfolio? Will any of those seemingly solid tech picks I've loaded up on turn into a disaster like Homestore.com -- the online real estate company that, to borrow a phrase from Enron whistleblower Sherron Watkins, "implod[ed] in a wave of accounting scandals" last fall. The only way to go about trying to answer these difficult questions is to take a long, hard look at the tangled and troubling accounting issues that continue to haunt the tech sector -- which is what I plan to do in a number of columns over the next few months. Let's start with one of the biggest, and weirdest, accounting issues now hanging over the tech sector: the bizarre way in which employee stock options are accounted for -- or, more precisely, not accounted for. You remember stock options, don't you? Back at the height of the tech boom, stock options seemed to many tech workers to be something close to free money. With tech stocks flying high, countless tech workers reaped gigantic windfalls by exercising their options to buy stocks at strike prices well below the market price at the time. These days, of course, most tech stock options issued at the height of the boom are now deep underwater, which is to say their strike price is higher than what the stock is trading for these days. (Go here for more on the gory details of stock options.) Full disclosure: As an employee of AOL Time-Warner, I'm holding some pretty soggy stock options myself. The price investors pay for free money Though stock options no longer look like free money to most employees, tech companies continue to give them out -- earlier this month, for example, Cisco announced it had issued stock options to half its employees, a move some interpreted as an indication that Cisco executives are feeling confident the company's stock price will continue to rebound. Part of the reason companies like options so much is that, in some sense, they are free money -- at least as far as the company's income statement is concerned. While common sense says that stock options, for better or worse, are a form of employee compensation, companies don't have to deduct them from earnings. (They are, however, required to disclose the effect in the footnotes of their annual reports, valuing employee options according to the widely used Black-Scholes model.) Critics of the policy suggest that it has enabled tech companies to significantly overstate their earnings in recent years. Given how liberally tech companies have bestowed stock options on their employees in the past few years -- most tech companies give them out -- the numbers we're talking about aren't small. Last year, Merrill Lynch tried to quantify the effect that expensing options would have had on the earnings of 37 leading tech firms. In the year 2000, the study found, the average tech company in their sample would have reported earnings 60 percent lower than they did had they counted options as an expense; some firms in the survey, including Juniper Networks, Lucent and eBay, would have reported losses instead of profits. You can figure this stuff out for yourself by looking for the Black-Scholes calculations buried deep in company 10-K filings. Looking at Microsoft's most recent 10-K, for example, we see that the company's reported earnings of $1.32 a share for fiscal 2001 would have fallen to 91 cents a share after deducting the cost of options. Strangely enough, companies are allowed to claim a tax deduction equal to the gain employees reap when they actually exercise their options; at the height of the tech boom, these deductions were so large that some tech firms were able to avoid paying taxes altogether. More free money! Screwy options accounting: It's not just a bad idea. It's the law.