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It's summer. We're at war. And Washington is abuzz
about . . . the proper accounting treatment of stock options that companies issue to employees.
Lined up for the status quo — that corporations do not have to report stock options as an expense when issued — are many conservatives and securities firms but also and most visibly, the American Electronics Association (AEA), which unfortunately is a group of lobbyists, not
hobbyists.
The most prominent of those advocates is John Doerr of Kleiner, Perkins, Caulfied & Byers — a leading venture-capital firm — along with Doerr's partners and peers. Doerr rallied much of Silicon Valley to support Al Gore in the 2000 election. Also weighing in for the status quo is Gore's earnest erstwhile running mate, Sen. Joseph Lieberman.
Those favoring treating options as expenses when granted include Alan Greenspan, Warren Buffett and former veep Dan Quayle. This week Coca-Coca, Washington Post Co. and Boeing all announced a voluntary switch to expensing options.
Defenders of the status quo raise three distinct arguments. After reviewing these arguments, I want to buy the stock of companies that manufacture tacks. For the executives who intone against expense treatment for options must be buying a lot of tacks to put in their shoes in order to keep straight faces while speaking.
Argument #1: A company will be at an unfair disadvantage if it has to reduce reported earnings by the cost of options. The fallacy here is that all companies would have to report in the same way, so no one would be at an inappropriate disadvantage relative to others.
True, startups may have less cash and more need to issue options, but it's also true that investors who aren't financially sophisticated enough to spot this difference probably should be investing through mutual funds rather than in individual stocks.
Argument #2: Options are not an expense when issued because there is no cash outlay involved. Eliminating the consideration of non-cash charges would set corporate financial reporting back a hundred years. Corporations have all sorts of non-cash charges: depreciation, amortization, deferred taxes and the like.
If the options were not really a financial cost to the firm, it's unlikely that managers would be in such a frenzy to get them.
The basic principle of counting expenses is that they should be recognized as expenses when they are reasonably certain and can be reasonably quantified. Hence the last ditch claim:
Argument #3: Options' value and therefore their cost can't be reasonably estimated. This is nonsense. Securities firms model the value of very similar exchange-traded securities with extraordinary care and detail. Their trading desks bet the firms' own capital on these models'
reliability. That the options granted to employees have longer terms to expiration and more restrictions on exercise than their exchange-traded counterparts doesn't change the result; the value of both of features can be estimated.
To anyone who talked about compensation with a senior executive of a major securities firm during the '90s, it is no secret at all why these executives and firms oppose treating stock options as an expense: They wanted more compensation and were convinced they couldn't get it if the
value of their long-dated option grants counted as an expense.
We have good reason to be skeptical when Al Gore's friends in Silicon Valley want to treat the real cost of stock options as another big secret, like Bill Clinton's medical history or Pinch Sulzberger's SAT scores. When the Financial Accounting Standards Board proposed this
technical change, Doerr and his allies in the venture-capital and technology industries gave workers time off to attend a "Rally in the [Silicon] Valley" against the change.
If you're an individual investor, keep something in mind: The venture capitalists who defend the status quo made billions investing in the same dotcom and telecom companies that you may have lost money investing in. Are you surprised that the VCs don't want to change how information
is distributed?
Fear not for the poor defenseless VCs: They will understand what a firm's financial statements mean, no matter how this issue is resolved. And remember that expensing options for financial reporting purposes is purely an information matter. It wouldn't require companies to pay more
taxes or make or market their products differently.
So the essence of the Silicon Valley/Wall Street case for the status quo is that U.S. companies will not be competitive if they have to account accurately for the costs of their employees. If that's true, the U.S.
economy is in a heap of trouble.
