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To: cfoe who wrote (122014)	7/23/2002 8:52:46 PM
From: Wyätt Gwyön	Respond to of 152472

What happens if the options are under water and expire unexercised. Does the company get to take the expense back as income? no. understand that what the company is giving as compensation is, precisely, an option which may or may not have value in the future (this applies to normal employees; the special options reserved for certain scumbag CEOs are often guaranteed money in the bank). but regardless of whether it has value in the future, it definitely has value at the time it is granted. the very real monetary value of at-the-money calls can be confirmed by checking the market prices for marketable calls at the CBOE site. employee options are even better because they usually last 10 yrs, which is much longer than the longest LEAPS calls. Or is the expense only recognized when the options are exercised vs. granted. I guess I am not clear on this. the second part is where options, upon exercise, affect cash flow and earnings per share. they have a (temporary) positive impact on cash flow at exercise (due to payment of strike price by employee, and due to tax credit from the IRS). meanwhile, they have a dilutive impact on EPS, because the issuance of new shares dilutes the earnings pie. some people think it is only a matter of cash flow, but this is misguided. exercised and outstanding in-the-money options can be included in diluted EPS. however, on an ex-ante basis, when a co grants new options, it does not immediately dilute its EPS, even though it has given its employees an immediate (or gradually vesting) compensation. therefore, expensing against income as they are granted (and/or vested) recognizes the very real compensation as it happens. for those that argue that this is not compensation, try taking away all option grants and see what happens. With many current options under water, aren't many folks working for much less compensation than they thought they were? perhaps, although some folks were probably overcompensated by options in the first place (all the people with 30K salaries at MSFT in 1992 who are now worth 30 million come to mind). going forward, if employees consider options undesirable, let them eat cash. they will demand more cash compensation, which is fine, and will be even harder for companies to exclude from their pro forma fantasies. while expensing options looks like the solution to a problem, I think people ought to try and look into the future and see what problems this solution will create well, that may be, but that is not an excuse for avoiding an examination of the current mess. one interesting piece i read the other day said part of the options morass originated when Congress forbad cos from writing off more than $1million in cash compensation per year to an executive. consequently, noncash options became the payment mode of choice. so you have all these jokers making a (to them) piddling million a year, even as their options plans give them hundreds of millions. pretending that is not a real expense to shareholders is scary indeed.

To: cfoe who wrote (122014)	7/23/2002 9:19:23 PM
From: Clarksterh	Read Replies (2) \| Respond to of 152472

What happens if the options are under water and expire unexercised. Does the company get to take the expense back as income? Or is the expense only recognized when the options are exercised vs. granted. I guess I am not clear on this. It depends. If, as is currently done in most (all?) pro forma expensing of options, the Black Scholes method is used to value the options at the time of issuance then the possibility of their expiring worthless is already priced in. So there would be no taking money back. But of course there are lot of other ways that people are talking about expensing them. Finally, while expensing options looks like the solution to a problem, I think people ought to try and look into the future and see what problems this solution will create. I guarantee you it will create new problems. I can think of at least one, although I am sure I will think of more that result from this new inherent disconnect between earnings and cash flow: 1) There could be more incentive for companies to manipulate their stock price in ways not beneficial to the market or the individual investors. For instance the fact is that stock options do not effect cash flow except via their tax effect and the potential future effect of their strike price. Companies, especially those with poor cash flows, will be incentivized to maximize the option value in order to minimize their taxes and thus maximize their cash flow. This is bad for obvious reasons. For instance if the options are valued using Black Scholes at the time of issuance then there will be incentive for the company to increase volatility, and this is something that is easy for a company to do and very hard to prove. Bottom line - it is dangerous to disconnect earnings from cash flow (i.e. integral(NPV(earnings-cash flow)) over a long time span is not equal to zero.) since it incentives companies to manipulate earnings to maximize the thing that they really care about - cash flow. Clark