TRACKING THE NUMBERS
Outside Audit
Rule Seeks to Uncover
Cost of Stock Options
Companies to Be Required
To Disclose Amount Spent
On Buybacks Tied to Plans
By MICHAEL RAPOPORT
DOW JONES NEWSWIRES
December 30, 2004; Page C3
As if it weren't enough to require companies to treat the employee stock options they issue as expenses, accounting-rules makers want to require companies to disclose more about any plans to buy back their own shares in connection with their options programs.
The little-noticed move by the Financial Accounting Standards Board, which sets accounting rules, should make it clearer to investors that many big issuers of options end up spending lots of cash repurchasing their shares as a consequence. Often, the intent behind these share buybacks is to prevent the raft of options, and the new shares that ultimately result, from diluting the companies' stock prices and per-share earnings.
By spotlighting the relationship between buyback programs and options issuance, the new disclosures could undermine a key claim of expensing opponents -- that issuing options doesn't cost a company anything, or that any cost is already reflected in the dilution shown on earnings statements.
"I think FASB wanted to be sure anybody who's concerned about the use of cash, which this is, will have an idea how much cash is going to go out the door," said Jack Ciesielski, publisher of the Analyst's Accounting Observer.
Officials of the International Employee Stock Options Coalition, an antiexpensing group, couldn't be reached for comment. In a fact sheet on its Web site, the group contends that many experts "find that there is no real cost incurred by a company when it issues stock options to its employees," and that, through dilution, "the so-called 'cost' of employee stock options is already accounted for and disclosed to investors."
As part of the new expensing rule it approved this month, the FASB said that if a company expects to buy back its own shares in connection with its options plans, it must now disclose that and provide an estimate of how many shares it expects to buy back for that reason in the coming year. The disclosure requirements will take effect with the rest of the new rule in the second half of 2005.
NEW DISCLOSURES
As part of its new rule requiring companies to treat employee stock options as expenses, the Financial Accounting Standards Board is requiring new disclosures about stock buybacks tied to options plans.
FASB says companies must:
• Describe their policy, if any, for issuing shares upon the exercise of stock options, including the source of those shares; and
• If the company expects to repurchase shares in the following year as a result, it must disclose an estimate of the number of shares, or a range if more appropriate, to be repurchased during that period.
A sample
Below is an excerpt from a sample disclosure provided by FASB to show companies what the information they provide might look like:
"The Entity has a policy of repurchasing shares on the open market to satisfy share option exercises and expects to repurchase approximately one million shares during 20Y2, based on estimates of options exercises for that period."
Source: FASB
Robert Herz, the FASB's chairman, said the board's intent was to help investors understand the impact that options issuance and related stock buybacks can have on a company's cash flow. The new rules weren't aimed at the idea that companies buy back shares to offset options-related dilution, he said, though dilution was a factor in the FASB's decision making.
Companies buy back shares for various reasons, of course, and it isn't always easy to separate out shares repurchased to offset options dilution from those repurchased for other reasons. By crunching some numbers drawn from a company's annual reports, however, it is possible to get an idea of how much a company might be spending if they wanted to offset the dilution from employee stock options as they're exercised.
At Cisco Systems Inc., for example, it appears it would have cost the company a net $641 million in the fiscal year that ended in July to buy back shares to counteract dilution from employee options exercised during the year. Cisco employees exercised options for 96 million shares in fiscal 2004; buying back 96 million shares at $22.30 a share, Cisco's average share-repurchase price for the year, would have led the company to spend a total of $2.14 billion -- nearly a quarter of its total share repurchases for the year.
Deduct from that the $537 million in tax benefits the company reaped from options exercises and the $963 million employees paid to exercise their options, and you get $641 million. Cisco officials couldn't be reached for comment.
Using the same methodology, Intel Corp. would have had to spend a gross $1.45 billion (about 36% of total buybacks for the year) and a net $594 million in 2003 to buy back enough shares to counteract the 63.7 million shares issued to employees during the year because of options exercises. Chuck Malloy, an Intel spokesman, said there is no connection between Intel's stock-buyback program and its stock-option program, and so "as we interpret the new rule from FASB, we don't think this disclosure applies to Intel."
Cisco and Intel are actually relatively modest when it comes to measuring these theoretical options-related buybacks against total buybacks. In a June report, Credit Suisse First Boston accounting analyst David Zion estimated that 77% of the share repurchases by Standard & Poor's 500 companies from 1999 to 2003 may have been made to offset dilution from options exercises. (Mr. Zion's calculation uses a stock's average price rather than the average buyback price, and focuses on the gross amounts spent on options-related buybacks, before tax benefits and payments of exercise prices are netted out.)
Write to Michael Rapoport at Michael.Rapoport@dowjones.com2
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