Andrew Odlyzko: A third perspective on stock option expensing

[Declan McCullagh <declan () well com>]

-------- Original Message --------
Subject: Re: Jim Delong's dissenting view on stock options expensing
Date: Thu,  8 Apr 2004 08:02:18 -0500 (CDT)
From: odlyzko () dtc umn edu (Andrew Odlyzko)
To: declan () well com

Declan,

Here is a comment on the recent exchange.  Please send it
on to the politech list, if you think it is appropriate.

Andrew


Jim DeLong and Martin Hutchinson take contrasting positions that
are both questionable.  Stock options are neither embezzlement
nor a triumph of "the creative class."  They can be very valuable
compensation instruments.  However, their current accounting
treatment (which basically ignores them) presents a distorted
view of an enterprise's financials.  Unfortunately, expensing
options will also lead to a distorted view.  The basic problem
is that options are rather complicated derivatives, and the
standard accounting measures are often inadequate in dealing
with them.

There is no simple way to see this, and one has to go through
some detailed examples that show what the effect of options is.
I did that once, using an extremely simplified model of a high-tech
startup that relies almost exclusively on options to compensate
employees, and a similar one that only pays wages.  This example
is presented in a letter to Barron's on this subject that I sent
them in 2002, and is available at

  http://www.dtc.umn.edu/~odlyzko/misc/barrons-options-letter-full

A very brief version of it was published in the August 5, 2002 issue
of Barron's, and is available at

  http://www.dtc.umn.edu/~odlyzko/misc/barrons-options-letter-edited

Andrew Odlyzko

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