Stock Option Expensing Rule Will Hurt
In the U.S. and at the international level proposed accounting standards would force all businesses to expense stock options provided to employees. The rule change comes in the wake of the big corporate scandals last year. Yet, small businesses may end up paying the price for this controversial “reform” enacted to clean up the actions of a few bad players.
Stock options are used by businesses to attract and retain talented employees. They’re an important tool for many small firms, particularly in the high-tech sector. Though bigger corporations can offer substantial benefit packages, they also find stock options to be a key incentive in attracting quality talent. But small firms contend they help to level the playing field for recruiting the best and the brightest.
”High-tech companies like ours need stock options for attracting and retaining the most capable workers. Stock options, given to the vast majority of our employees, provide our companies with a competitive edge for keeping skilled workers,” said Dick Cook, President and CEO of MAPICS, an enterprise software developer and Chairman of the American Electronic Association (AEA), whose membership is largely made up of small companies (www.aeanet.org).
With escalating health insurance costs and high expenses associated with establishing and administering pension plans, will small businesses find themselves down another benefit option to attract and keep quality employees? If the Financial Accounting Standards Board (FASB) moves forward with its proposal to mandate expensing the answer is a resounding “yes,” according to those who offer options to employees.
Mandated expensing makes little accounting sense; will not give investors accurate or reliable information; would incorporate flawed models for valuating options; and will destroy broad-based plans, according to those who say there’s a better way to financially capture stock option activity.
FASB is the organization that establishes standards of financial accounting and reporting in the United States (www.fasb.org). Their proposal has not been popular with the business community.
Cook and scores of other high-tech executives visited Capitol Hill recently to educate Congress about the FASB proposal and advocate for bipartisan legislation that would improve financial transparency and reporting without harming the future of stock options, or the businesses that provide them.
“We’re here to let Congress know that the Financial Accounting Standards Board proposal to expense stock options will hurt rank-and-file employees’ ability to participate in the ownership of their own company,” expressed Cook.
Expensing doesn’t make accounting sense. There is no cost incurred by companies when they issue stock options to employees. Rather, they represent `capital income` and not compensation. Therefore, the basic expensing precept is misguided.
“Options remain a good deal for average workers, even today. For one thing, most companies grant them over and above the market wage they pay. They do so because options represent a share of the firm’s future wealth; they’re a form of profit sharing, which means they’re capital income, not labor income,” according to the findings of Rutgers University professors Joseph Blasi and Douglas Kruse.
Their book, In the Company of Owners: The Truth About Stock Options (And Why Every Employee Should Have Them), defines stock options as “risk sharing based on joint property ownership.” This “partnership capitalism” boosts corporate productivity, enhances shareholder returns and spurs innovation.
Employee stock options are already accounted for and disclosed through “diluted earnings per share.”
Valuating stock option is complex and unreliable. Existing models for valuating options can yield very different results depending upon the assumptions that companies use. The current models were created to value short-term, freely tradable options, which are different from employee options.
Beyond incompatible models, a company can’t accurately guess when an option, or options, will be exercised. Still, they would be required to estimate the “costs” up front, recognize them, but not be given the opportunity to correct those estimates if they were wrong. The roller coaster ride of the stock market over the past several years demonstrates the complexity, not to mention the financial hazards, a company faces if forced to expense stock options during volatile market periods.
The end of broad-based stock options? If expensing is mandated, all-employee plans would be more “expensive” from an accounting perspective. Such broad-based programs would go by the wayside while executive plans prevail. Professor Blasi sees the law of unintended consequences taking hold as expensing leads to stock option concentration.
“Expensing will make the problem worse. It will concentrate more stock options in the hands of executives. It’s an ironic Greek tragedy if our solution for corporate reform is to exterminate employee ownership for the rest of the country and keep if for top executives,” writes Blasi.
Bipartisan legislation has been introduced that would preclude the need for mandatory expensing. The Broad-Based Stock Option Transparency Act of 2003, introduced by Reps. David Dreier (R-CA) and Anna Eshoo (D-CA) in the House, and Senators John Ensign (R-NV) and Barbara Boxer (D-CA) in the Senate, directs the Security and Exchange Commission (SEC) to establish new financial disclosure rules for stock option plans (www.sec.gov). Under the proposal, the SEC would monitor the effectiveness of the enhanced disclosure and reporting requirement for three years, and report their findings to Congress.
During the three-year period, the SEC would not recognize the FASB stock option accounting standard.
“The SEC needs to examine the broader impact of this decision before unaccountable officials create rules that will destroy incentives and rewards to rank-and-file employees,” remarked Senator Boxer. The FASB proposal, she added, is “bad for workers, bad for the economy, and bad for investors.”
Not to mention small businesses, which are increasingly using stock options to innovate, grow and survive in our competitive economy. Karen Kerrigan is chairman of the Small Business Survival Committee.
