Here's that article . . .
Changes May Be Coming
For Stock-Option Accounting
By ROGER LOWENSTEIN
In the 1930s, after the stock market had crashed, public
hearings revealed that the Morgan bank had favored
well-known politicians and other cronies with hot new stock
issues at bargain prices. When the public found out about this
legal-but-undercover-and-excessive lucre, it was nauseated.
If there is ever an accounting of the current era, the spotlight, I
believe, will shine on the legal-but-excessive pay pocketed by
corporate kingpins. But no one will be able to say, as in the
'30s, "How could we know?" This time, the tune will be, "We
didn't want to know."
The Financial Accounting Standards Board fought a long battle
to force corporations to record the expense of stock options
but caved in when high-tech industries persuaded Congress that
without the ability to sanitize their earnings, Silicon Valley
would revert to the stone age. The FASB, which has yet to
regain its respect (lotsa luck to its new chairman, Edmund
Jenkins), settled on a humorous compromise: Every company
would disclose in a footnote the earnings it would have
reported after deducting options, but its actual reported
earnings-the number that goes to investors, securities analysts,
Wall Street, the press, the chief executive's mom and other
interested parties-would be unencumbered.
The issue won't go away because options are multiplying like
rabbits, because the footnotes (this is their first year) are baring
some interesting numbers and because legislators turned off by
paychecks that are literally unaccounted -- for are making
noise.
Bill Archer, House Ways and Means chairman and no
Trotskyite, flirted with but dropped a plan to curtail tax
deductions for options. A more-interesting, bipartisan proposal
still is breathing in the Senate. John McCain (R., Ariz.) and
Carl Levin (D., Mich.) have co-sponsored a bill, which they are
hoping to tack on to the pending tax package, to limit
deductions for options to the amount that companies expensed
on their earnings.
You have to think about this carefully to gather in the irony.
When companies report to the Internal Revenue Service, they
eagerly deduct the expense of options, thus reducing their
taxes. There are those who maintain that the expense isn't
"real" and that the deduction amounts to a
subsidy-cum-corporate-welfare, but you won't find anyone at
the Business Roundtable taking that view. "On the tax issue it
clearly is a legitimate expense," Ken Glueck, Oracle's man on
the Potomac, told me.
But the issue of how to treat options in the earnings statement
is, according to the same Mr. Glueck, "a true conundrum." On
form, companies that are powerfully clear-headed when a tax
deduction is at stake are overcome by accounting subtleties
when it comes to taking a hit to reported earnings.
Under McCain-Levin, companies could still take the tax
deduction, but only to the extent that they also took the
earnings hit. (The FASB already encourages companies to
record the expense, but none that I know of do so.) This would
be decision time for CEOs. They would have to choose
between a tax deduction or higher reported earnings-more
bluntly, between hard cash and accounting fiction.
You'd think that would be a nonissue -- take the cash, drop the
fiction, right? Not so fast. Companies are apoplectic about
McCain-Levin (and will probably stop it in its tracks).
Preserving the fiction that options don't have a cost is what the
fight over options has always been about.
For some big companies, such as General Motors, the effect of
expensing options would be immaterial. For others, like
Seagram and MCI Communications (see chart), it would knock
off more than 5% of earnings. For start-ups like Netscape it
would wipe out current earnings entirely.
The cry in the Valley is that options are part of the culture;
software geeks get most of their reward from stock options
and wouldn't work without them. So be it. No one's taking
them away. But as matters stand, the Netscapes of the world
are telling shareholders that their help largely works for free,
which they don't. By expensing options, they would be saying,
"We have made promises to share a large part of our future
profits with the staff." Which is a fact. Microsoft, for instance,
earned $1 billion in the first quarter of 1997, yet spent double
that on buying back stock. Despite repurchasing all that stock,
its shares outstanding fell only slightly, due to its issuance of
options. As far as the income statement is concerned, the
quarter's profits seem to have disappeared. So options would
seem to have some cost.
McCain-Levin has some flaws in the details, but by proposing
to use a company's self-interest as a hammer to encourage
honest reporting, it's the most intriguing fix on the table. As
with disclosure remedies generally, markets (albeit better
informed ones) would still make the call. CEOs would be free
to decide what markets valued more-accounting form or real
money. Shareholders would be free to discount, or not to
discount, shares with lower reported earnings. At the margin,
management might cut back on options -- it would depend on
competitive pressures. But then, cutting the cake between
capital and labor always involves a trade-off. To argue that
telling the truth risks a bad result is contemptible.
Less Than Meets the Eye
Reduction of reported earnings from including the cost of stock
options on 1996 earnings (1)
Company
Effect
Company
Effect
Netscape
-296%
MCI Comm.
-8.1%
Westinghouse Electric
-129
Alcoa
-8.2
Reynolds Metals
-18.3
Georgia-Pacific
-7.6
Seagram (3)
-17.4
United HealthCare
-7.4
Armco
-14.3
CUC Intl. (2)
-7.3
Unocal
-14.3
Pepsico
-6.9
Genentech
-12.5
Amgen
-6.6
Inland Steel Industries
-9.3
Avery Dennison
-6.0
(1) This list is selective. Not all companies have reported.
Figures represent change from net or net primary earning per
share. In addition, companies that reported net losses before
options weren't included.
(2) Year ending Jan. 1997
(3) Period ending June 1996
Source: Company reports |
