Don, I still owe you a response.
When we left off, I got the impression you were claiming that the company does not suffer an expense if it issues payment in its own stock.
In one context this is true. However, in the context of making shareholders (the owners of the company) richer or poorer, this has limited usefulness, as true as it might be. If the company gives something to employees that have no value to the company but value to shareholders, then the company's account is not debited, but the shareholders' is. Which is the case with payment in shares for which partial or no payment is received in return.
I think where we differ is whose responsibility is it to REPORT the change in wealth of the shareholder.
If the company, instead of giving shares to an employee, takes shares out of the company vault and burns them, has it suffered a loss in the process? What if it gives the shares to the next ten people who walk by the company's front door?
This is a silly example. If you, instead of writing checks to your electricity company take checks out of your drawer and burn them, have you suffered a loss in the process? What if you give checks to the next ten people who ring your doorbell?
Pretend for a second that you are incapacitated. That you have designated someone as power of attorney over all of your assets. If your attorney writes "payable to bearer" and "one N'th of Don Lloyd's assets" in the appropriate spots on an un-dated check drawn on your account, the pile of assets doesn't change in size. Your claim on the pile does. Even if that bearer check is never cashed! Such an act renders you less well off. Although the pile of assets in the account is neither increased or decreased until the bearer comes by and says "pay up".
So, take your pick. Do you want your attorney reporting to you how much is in the account, or how much of what's there you can spend?
If instead of demanding payment, the bearer swaps this check to someone else for cash representing what this third person estimates is 1/N of your assets, you still aren't any better or worse off and a whole sub-economy in trading Don Lloyd's bearer checks could launch itself.
But the only way you get better off is if the actual pile of assets increases faster than your attorney writes checks payable to bearer.
If you were so silly as to only demand from your lawyer a statement of changes to your account, this would not deliver to you a complete picture of changes in your spending power. And if you decided to reward your lawyer's husbanding of your assets based solely on how much the account goes up and down, you can bet he'd want to pay as little as possible out of the assets of the account, and more and more on these bearer checks to which you aren't paying full attention.
Now, you asked me whether a company's own stock is an asset or not.
The operative question here is "to whom". Stock is remarkably similar to an undated check, payable in fractional amounts of net worth, made out to bearer that hasn't been cashed, and generally doesn't get cashed.
So it is not an asset to the company (the attorney). But it is an asset to the owner who can pledge it, exchange it or maybe even cash it in.
As far as: The problem with expensing stock grants is that it double counts the degree of injury to the existing stockholders. If something is an expense to the company, it must reduce the value of the company below what it would otherwise be. This decrease in value must impact the shareholders. But they are also impacted by the dilution in their share of the total company that they own. You can't have both injuries and properly reflect the reality of shareholder value.
Not quite Don. I can count my nipples on my fingers. I can count them on my toes. If done properly, I will end up with the same number. I can count the same thing two different ways and still properly reflect the reality of the situation.
Expensing of stock options isn't so much "double counting" of dilution as "precisely counting" of dilution. Most people think dilution is just an increase in share count. They are wrong.
Instead of general hand waving arguments, let's use an example with real numbers.
Let's say we constitute BBRCo and capitalize it with 200 oz of gold and 200 shares of QCOM. And let's say ownership is one share to the author of each of the last 100 posts. Each post would thus be 'worth' 2.0 oz of gold and 2.0 share of QCOM.
Scenario 1: we issue another share. To me, for this post. And because my opinion has no value whatsoever, I agree to pay BBRCo "fair value" for the share, namely 2 oz of gold and 2 shares of QCOM. So now the account stands thus: 101 shares, 202 oz gold, 202 shares QCOM. And 101 posts to this thread.
Scenario 2: we issued this share to me in lieu of compensation. As pure payment. Now there are 101 shares with claim on 200 oz gold and 200 shares of QCOM. And 101 posts to this thread. Each shareholder has had their claim reduced, although the assets of the company remain fixed.
Scenario 3: in return for the share I paid 1 oz of gold and 1 share of QCOM, perhaps as though I had cashed in an option granted to me some time ago in consideration for me hanging around to write a post such as this. So the company faces 101 shares with claims on 201 oz gold and 201 shares of QCOM. And 101 posts to this thread.
All three scenarios have the same share count, and the same rate of increase in intangible assets, but different shareholder dilution.
Shares Au QCOM $Value $V/Sh Dilution
Start 100 200 200 77,000 770
Scn 1 101 202 202 77,770 770 $ - 0 %
Sce 2 101 200 200 77,000 762 $ 8 1 %
Sce 3 101 201 201 77,385 766 $ 4 0.5 %
Three identical outcomes in terms of "operating results" (one post), but the company ends up with a different amount of increase in assets per share! Clearly, these represent different profitability!
If shares are issued and the company gets back what these shares are worth, then nobody ends up better or worse off: there is no dilution. If shares are issued and the company gets back less, then existing shareholders end up with less than they had before and thus there is dilution.
Back to the example. Assume these shares were given to me as part of my compensation package. In all three cases the company got the same amount of work done (this post). The company ended up with the same shares outstanding. But clearly the profitability of the company (change in value to the last 100 shareholders) is different!
These shares were payment for services rendered (which I might have taken in cash or oz AU or shares of Qualcomm, or twinkies for that matter). The reason for the change in asset value belongs on the income statement as compensation expense. The difference in profitability is equal to the expense that should have been charged. In the first case, zero. In the second case 2 oz gold and 2 shares QCOM. In the third case 1 oz gold and 1 share QCOM.
What about EPS? Well, in all three cases the EPS (fully diluted) is different. Not because of the number of shares is different, but because the actual change to the net value of the company is different!!! And the difference in net value is due to a difference in what it cost (shareholders) to get me to write this last post.
So you see, the difference we would account for under compensation is not double counted after all.
As an aside, for completeness, if these transactions were for financing (a secondary offering, for example) or in exchange for capital assets, then the reason for the change in asset value of the firm does not belong on the income statement, it belongs on the statement of cash flows. These would be dilutive (or non-dilutive) financing transactions.
As far as: If I tell you that the President of a company has 1M shares that he didn't pay for, and that's all that I tell you, you have no way of distinguishing whether the shares are the result of direct company compensation or the result of a stock split which is followed by the shareholders personally giving their split shares to the President themselves. In both cases the company, the President, and the shareholders all end up in EXACTLY the same condition. There can be no logic that allows only one of the two possible sequences that end in the same place to be an expense.
Very concisely viewing the expense to the company and the expense to the shareholders as two separate activities. Feel free to make that distinction.
Personally, I believe that distinction to valid, but incomplete.
I and the rest of the shareholders own the assets of the company. If the company earns $1 for each of us, every year, we might call the company profitable and be willing to forego capital that would earn us $1 elsewhere in order to buy it. We might even have given it a PE of 100 in the bubble days.
What if a very similar company REPORTS to us that it is earning $1 per share every year, but is able to do so ONLY because in another (related) transaction we (shareholders, plural) end up giving $2 per share to employees in cash after parting with 2% of the company? Is that the same value to us? We're down a buck a share when the dust settles. Is it the same value to us as calling it $0.98 per share (fully diluted)? But during the bubble days folks were quite willing to give such a company a "PE" of 100.
I think it should be obvious that on an EPS or EPS(fully diluted) basis, a company that indulges in stock compensation APPEARS to increase the wealth of its owners far more than it does.
As far as whether it is more profitable to itself... well, that might be a useful measure to someone, somewhere. But companies don't exist in and unto themselves. They exist to the benefit of their owners.
You are focused on the cost of stock compensation TO THE COMPANY. Like the cost of writing a check to the dollars in the bank account.
If you want to draw the line there, then so be it. I just think that the important boundary is to TO THE OWNERS, and that the company has a responsibility to reflect the wealth change TO THE OWNERS as a result of its actions. Which includes the cost of promises that the owners will cough up something in the future in exchange for work done today.
This is very similar in macro context to governments printing money. Or burning it. Doesn't change the absolute wealth of the nation. Just changes the number of claims on that wealth. Is the nation any richer or poorer?
Depends on which side of the border you stand.
John |
