The Coming Expensing of Employee Stock Options 222
An anonymous reader writes "This accounting change will reverberate loudly throughout geekdom.
"Users of financial statements...expressed to the FASB their concerns that (the current handling of stock options) results in financial statements that do not faithfully represent the economic transactions affecting the issuer, namely, the receipt and consumption of employee services in exchange for equity instruments. Financial statements that do not faithfully represent those economic transactions can distort the issuer's reported financial condition and results of operations, which can lead to the inappropriate allocation of resources in the capital markets." Taken from FASB Statement of Financial Accounting Standards No. 123 (Dec 2004). A
FAQ has been published as well." Yes; the data is from 12/16/04, but this will be a huge change in how tech companies work.
Does it mean LESS stock options, or not? (Score:2, Interesting)
But will it really change the packages on offer? I guess that everyone from CEO down wants to retain stock options. They will just look more expensive to investers i.e. they will get a better view of a firm's financial behavior.
The relevance to slashdotters, is of course that tech companies have had the growth profile and preferred this "cool" way of rewarding directors and staff.
-- In Sri Lanka they aren't worrying about their STOCK OPTIONS being underwater. --
Mostly implemented (Score:3, Interesting)
Jerry
http://www.syslog.org/ [syslog.org]
Re:Stock options? (Score:4, Interesting)
Dot-com era tech companies aren't the only ones that used stock options as incentives. Our fortune 500 company of over 200,000 employees has traditionally distributed stock options to its management employees as part of a bonus package. This year they won't, but it remains to be seen if we'll get cash, straight-out stock, or a screw-job.
Re:Why this is important.. (Score:2, Interesting)
Microsoft has fought this since it was first suggested. Some reports put Microsoft at a loss instead of profit for several years because they (Microsoft) were able to hide employee expenses in the stock options.
It remains to be seen if this rule change will have much of an affect outside of reducing stock options more than the dotcom bubble burst did.
Re:Why this is important.. (Score:2, Interesting)
Hmmm... (Score:4, Interesting)
1. It is not really possible to properly account for option grants vis a vis cash vaule because: a. options are a hedge AND b. options may not be cashed out (employee leaves/dies, stock is underwater)
2. If 1 is true, then you get an equally distorted view AFTER this decision as before
The argument that investors will have a better idea of the business as a result of this is not really accurate, either. After all, institutional investors already follow option grants, so this isn't hidden. If you don't follow this kind of data for any company you invest in, you're simply willfully ignorant.
Re:Eh. (Score:3, Interesting)
Except that a stock option is not really a "cost"; it does not deplete the company's assets to issue them. If any dilution occurs, it is when shares are issued and/or set aside for the purpose of issuing stock options, and, as I understand it, this is something the shareholders have to explicitly approve and is therefore duly noted in the company's financial records.
Now they have to expense them using "fair value", which is what an investor would currently pay for an equivalent option. This, in theory, will more effectively represent employment costs.
My only problem with this is that, as the FAQ points out, there is not really an exact equivalent available to the general investor. Which means the calculation of the "value" of an option is something of a fiction, which is not accounting as I thought I understood it (and I never thought I did...).
I would have considered it more accurate to regulate how shares that are set aside for options are accounted for. If I'm worried about options, I would be able to figure out how vulnerable the stock price is to sudden shifts in ownership due to option exercises, just like I can figure that out based on company reporting of large blocks of outright ownership.
Re:Eh. (Score:2, Interesting)
http://www.billparish.com/msftfraudfacts.html
http://www.usagold.com/gildedopinion/micro
"3) Convincing Employees to Take Less Real Wages: Microsoft aggressively markets stock options to new employees in an effort to take wage expenses off the books. They also know that they can pocket the exercise price employees will be required to pay to take ownership of the stock. What also seems clear is that Microsoft is still aggressively marketing its stock option program to new recruits. To quote an email received, "I am about to begin employment at Microsoft and the stock option was the selling factor. Does your article overall state that it will be bad for me and will fail me in my retirement planning?" Is Microsoft fulfilling its disclosure obligations to its own employees, especially those that have put their entire 401K balance in Microsoft stock? This explains how 22 percent of Microsoft's massive cash balance has actually come from its own employees in the form of them prepaying their own wages through stock option exercise prices."
This is only one aspect of the total scam which that article details.
keep screwing the little guy (Score:4, Interesting)
that's kind of the point. This rule, just like every other rule made under the Bush administration, is about screwing the little guy at the expense of (a) large corporations, (b) financial institutions, or (c) extremely wealthy individuals. If you go to work for a very early-stage company, and you are one of the first, say, 20 employees, you are really taking a risk- becuase the odds are that your tiny company just won't be around in 5 years. If you have a two kids, a mortgage and a car payment, how do you think it would impact your life if the company you work for suddenly couldn't make payroll? That's right, even with six months' savings in the bank (which you don't have) and a $10k limit on your gold card (of which you've already used $7k), you're going to be scrambling to find work. If I'm going to risk my livelihood for a dream, I expect to be rewarded handsomely.
But a small company can't afford to pay you more in cash than a company like Cisco or Oracle, so that small company needed a way to reward quality employees for hard work and loyalty. That's what stock option grants at startups were about- the company rewards its employees for taking a risk, but is legally still solvent. And yes- it does revolve around luck, and when you got in- becuase if you join a company as the 100th employee or the 1,000th employee, it should be clear that you're making a much safer bet than the 10th employee was when she joined. High risk, high reward.
Under the new rules, there's no easy way to reward early-stage employees for their risk-taking except to pay them more cash. And until the company is doing well financially, an employer can't afford to do that. Catch-22.
This rule change will make no difference to CEOs of Fortune 500 companies, becuase they'll still get paid $lots. It won't change the risk involved for institutional investing, so the i-bankers and vc's will still have the same issues to worry about. If anything, it will make the i-banker's job easier, becuase there is one less number they have to add to the financial statements if the reporting company is putting it in there for them already. It will slow down the progress of startup companies with disruptive technologies, becuase it will be harder for them to motivate quality people to leave their current employers. It's a minor accounting change for a Fortune-500 company, and death knell for the way that startups recruit talent... which is probably music to the ears of those F500 companies who can now pay their regular employees LESS because they don't have to worry about as much competition for their talent.
It sounds like you were the beneficiary (in spades) of the old system- you of all people should recognize the upside! The only real impact this rule change will have is to make it more difficult for very early stage startups to attract and retain quality employees- which is great for everyone, except entrepreneurs, their early-stage startup companies, and their employees...
Re:Eh. (Score:1, Interesting)
Re:Stock options? (Score:3, Interesting)
Ehh, sort of. You don't "write off" options. You don't pay anything for options, the shareholders end up eating the cost, so there's nothing to write off. Salary, under $2million, is tax deductible so you would write that off. This was imposed so that people could more easily view a company's true earnings, factoring in work done by employees that was compensated by the shareholders (via options). Here's a quick ridiculously simplified example.
Company A makes $10 million in revenue and has $5million in salaries, blah blah blah has a net income of $5 million this year.
Company B makes $10 million in revenue and has $2.5million in salaries, thus having a net income of $7.5million. They also granted $5million in options@$3 which were sold @$3.5, resulting in $2.5million dollars of compensation for companies paid (basically) by the shareholders via the stock price.
With the new rules, companies will be forced to estimate the value of options on the date of grant. Therefore, Company B will have a net income of somewhere around $6million to $7million depending on what the estimated value of those stock options are.
To answer the question: "Why don't they just wait to see exactly how much the options were exercised at and account for the actual cost of the options?"
Three reasons.
1) People claim it's unfair to companies who perform well, as they'll have higher stock option expenses. More importantly is point 2).
2) It's a serious pain to go back through the last 10 years of accounting statements every quarter and re-do all 10 years. How would you like it if you were following a company and every quarter you had to re-evaluate all 10 years of that. It's just not feasible.
3) When you estimate the grant of options, it's what those options were worth at the time (or their "fair market value"). If your stock was $1 and it went up to $100, it's not fair for the company to expense all $99 of that increase, because no one knew it was going to do that.
There are two drawbacks to expensing.
1) Companies whose stock drops and sees no expense from options will still have to expense their estimated value when they issued them. (Which is fair, because if their stock skyrockets they still only expense the estimated value).
2) Depending on how expensing is set up, there may be a lot of room for manipulation of the numbers. If companies have too much control over the assumptions that go into expensing formulas, the estimates may be overly optimistic and misleading. For example, on a 10 year option, if you estimate that most will exercise that option within 2 years, that seriously reduces the values of those options. There is a difference between Binomial model and the Black-Scholes model, which I won't go into here. But FASB needs to seriously address this issue.
razzakjallow@yahoo.com