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No Easy Fix for Stock Options Angst

Accounting: Some analysts say the push for changes in expensing the incentives is based on a flawed premise.

August 11, 2002|JAMES F. PELTZ | TIMES STAFF WRITER

Amid the controversy about whether companies should treat employee stock options as a normal cost, only about 50 of the nation's 13,500 publicly traded companies--that's 0.4%--have announced plans to voluntarily make the switch. And it's by no means certain that the trickle will become a torrent any time soon.

Standing in the way is the debate raging over the effect the accounting change might have on the companies' financial results, their stock prices and their employees. One side contends the effect will be hugely negative--lowering corporate earnings and paring the number of options granted to executives and non-management workers. Others speculate that the effect will be minor.

The whole premise behind expensing options is to further clarify a company's accounting, make its numbers more transparent to the public and thereby boost investors' confidence, which has been ravaged by corporate scandals.

Executives involved in those scandals were often lavished with options that made them fabulously rich and allegedly prompted the financial abuses that were aimed at keeping the companies' profits--and stock prices--as high as possible. So options came under assault, and now treating them as a cost to be deducted from earnings is seen as one solution to curbing the abuses.

But some analysts say many investors probably will ignore, or "back out," the cost when they evaluate a company's stock on grounds that a company doesn't immediately pay out cash when it grants options.

Others argue that there are eventual costs. Options increase the potential number of shares a company has outstanding, which could lower its earnings per share that Wall Street and other investors follow so closely. In turn, companies often then spend heavily to buy back their shares on the open market to offset that dilution.

Expensing options will make companies more cautious about how many options they issue, some observers say. But others disagree. "At the end of the day it's going to be a non-event," said David Hilal, technology research director at investment firm Friedman, Billings, Ramsey & Co. in Arlington, Va. "I don't think employees need to be alarmed at the prospect of getting fewer options."

Practices Unchanged

And despite the turmoil surrounding the issue, companies so far "have not scaled back their use of stock-based compensation" to motivate employees and attract new talent, according to surveys by WorldatWork, a trade group in Scottsdale, Ariz., that tracks worker compensation and benefits.

The debate has "yet to convince a majority of companies to reconsider how they administer their options plans," the group said.

Even so, the confusion is expected to increase as more companies deliberate whether to expense their options and while the Financial Accounting Standards Board--which sets the rules for corporate accounting and favors expensing options--ponders whether to make the change mandatory.

Many analysts are hard-pressed to think of another issue in recent years that has so divided the sharpest minds in corporate America and on Wall Street.

On one side there are the likes of General Electric Co. and Coca-Cola Co., two multinational behemoths that plan to expense options to boost investor confidence in their accounting. On the other side are Intel Corp., Cisco Systems Inc. and other technology titans that oppose the switch, claiming it would brutally hurt their profits.

Others also oppose the idea, including former American Express Corp. Chairman Harvey Golub, who contends that because options don't actually cost a company anything initially, there is no reason they should they be deducted from earnings. Another reason: the confusion over how the options should be valued.

Methods Will Differ

Analysts say these factors will limit the practice of expensing options in the immediate future. Investors and employees will be forced to grapple with different options-accounting methods at different firms until the change becomes mandatory, or some trigger prompts most firms to start treating options as a routine expense.

Neither is expected to happen until next year, at the earliest.

Options give holders the right to buy their company's stock in the future at a set price. The idea is to give employees an incentive to work harder so the stock's market price climbs higher than the option price. Then the employee can exercise the option, acquire the shares and resell them for a profit.

Companies that issued these incentive options have done so without having to put a precise value on those options and to subtract that cost from their profits. However, under a 1995 ruling by FASB (known as Ruling 123), companies were required to place a "fair value" on the options and arrive at a pro forma, or "as if," calculation of how that cost would have affected their earnings.

The Numbers Are There

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