An argument for making U.S. firms expense stock options

[Declan McCullagh <declan () well com>]

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http://www.upi.com/view.cfm?StoryID=20040402-083837-5018r

  The Bear's Lair: Lobbyists of fraud

By Martin Hutchinson
Published 4/5/2004 12:53 PM
View printer-friendly version

WASHINGTON, April 5 (UPI) -- For sheer chutzpah, Intel chief executive 
officer Craig Barrett's Wednesday piece in the Wall Street Journal, 
explaining why he opposed expensing stock options, took some beating. 
The following day, it was revealed that Barrett himself doubled his 
allocation of stock options in 2003, presumably on the principle of "Get 
it while you can."

The exposure draft by the Financial Accounting Standards Board, 
recommending that stock options be expensed on the income statement, 
although remaining agnostic on the method, produced an even greater howl 
of outrage from the tech sector and its tame politicians than had been 
expected. Most ominously, House Minority Leader Nancy Pelosi (D.-Ca.), 
who presumably has many tech sector constituents and donors, and House 
Speaker Dennis Hastert (R.-IL.) who cannot possibly have the same excuse 
(at least in the case of the constituents) vowed to introduce 
legislation preventing the FASB from doing its job.

When politicians, particularly those with the intellectual 
qualifications of former wrestling coach Hastert, start setting 
accounting rules, the U.S. financial system is in trouble!

Make no mistake about it: the current method of accounting for stock 
options may not legally be fraudulent, but economically it is fraud. It 
pays employees and management something of immense value, that directly 
reduces shareholders' wealth, and then declares to shareholders that no 
value has been given. It is thus similar to embezzlement, which (because 
the embezzler knows he's got the embezzled money whereas the victim 
doesn't know he's lost it) also produces "higher productivity, higher 
returns on equity, higher returns on assets" (Barrett's words) -- until 
the embezzlement is discovered and the victim realizes something has 
been stolen. Technically, discovering embezzlement, by lowering the 
total of perceived wealth, through the "multiplier effect" reduces gross 
domestic product. It is on this level, and only on this level, that the 
current mis-accounting for stock options costs can be justified.

Barrett goes on to claim that if options costs are expensed "no wise 
investor or professional analyst will pay much attention to the expense 
figure." In that case, his argument that expensing would reduce 
productivity, return on equity and the joys of motherhood makes no sense 
-- how can a figure to which nobody pays attention have any effect at all?

Thomson FirstCall, the earnings estimates reporting service, has 
announced that it will strip out options costs when calculating 
quarterly earnings, so that those companies that have switched to 
options expensing are not penalized compared with their competitors. 
This is not really a defensible position even while only some companies 
expense options, because the volumes of options granted varies so 
enormously even within sectors, so that some companies, such as E-Bay 
and Cisco, would in most years lose their earnings altogether if options 
were expensed properly. However, Thomson FirstCall uses primarily the 
sell side analysts to calculate its estimates; there is no question that 
the sell side -- brokers attempting to peddle stock -- benefits 
enormously from having earnings numbers artificially inflated, 
particularly in the tech sector where earnings are so scarce.

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