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The Honesty Option

July 31, 2002

Now that President Bush has signed a tough measure to reform accounting practices and make outright corporate fraud easier to detect and punish, on to subtler but still necessary stuff. To reassure investors both big and small that what they see is what they get, the distortions caused by overuse of stock options must be eliminated. The stock exchanges are starting to do it, as are a few companies.

Stock options, when properly focused, can put management and workers in tune with shareholders' wishes by sharing some of the wealth created when the stock price rises. High-tech companies with limited cash use options to attract and keep employees; big companies use them as incentives for executives and workers facing tough economic swings and increased competition.

But options also generate abuses when executives twist quarterly profit figures to drive up the stock price and thus the value of their options, which are usually an offer to sell them shares at a set price after a certain date.

The New York Stock Exchange is heading toward adoption Thursday of a requirement that member companies submit stock option plans to shareholder votes. It's an important step because executive pay packages too often are designed by corporate boards that take their marching orders from the very executives who stand to benefit.

The stock exchange also wants member companies to provide shareholders with clearer explanations about the possible costs associated with stock option programs. But one step beyond these measures is needed.

The NYSE should demand that companies treat stock option plans as expenses. That would give shareholders another reason to believe that they're getting honest corporate earnings statements, because option packages can have a considerable effect on profit. Merrill Lynch has reported that earnings at the nation's 500 largest publicly traded companies would have dropped by 21% during 2001 had options been counted as expenses.

TIAA-CREF, which manages more than $274 billion in assets for school and university employees, is one of the nation's biggest institutional investors. It recently urged top executives at 1,754 publicly traded companies to begin voluntarily expensing options. Those investors who went along with bloated option plans when rising stock prices buoyed their own shares should start insisting that plans reward executives for sustained excellence.

Forward-thinking companies already are acting on the steady nagging of respected mega-investor Warren Buffett. Coca-Cola Co. and Washington Post Co., two that count Buffett as an investor, have taken the lead. More companies should join in--or risk more regulation.

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