Counting Your Options
Interview by Donna Guzik
The Accounting Standards Board plans to require companies to put stock options plans on income statements. That will put Canadian companies at an accounting disadvantage, says Financial Executives International President Harvey Naglie
Transcript
IC: Welcome to InvestorCanada.com. I’m Donna Guzik.
The Accounting Standards Board wants to push through a rule as early as next summer that would require publicly-traded companies to treat employees’ stock options as an expense. Right now, companies have the option to choose whether or not they want to do that.
According to Harvey Naglie, this is a slippery slope that may do more harm than good. Mr. Naglie is the Canadian President of Financial Executives International. Mr. Naglie, what’s wrong with making everybody expense their options?
Naglie: There’s nothing wrong in principle. What is wrong is that we are getting out of sync with the United States and given that many of our businesses and industries compete directly with their counterparts in the US, I’m troubled by the fact that Canadian companies will now be at a competitive accounting disadvantage.
IC: How does this put them at an accounting disadvantage?
Naglie: Stock options are most popular among intellectual property based companies, technology companies, telecom companies and it is a very effective way to attract new employees. My concern is by virtue of the fact that Canadian companies will have to expense those options, they won’t be in a position to make those offers to prospective employees; and consequently, those employees may find themselves going to American companies.
IC: The argument is that expensing options will lead to net losses for some companies, and that’s really the reason why a lot of the companies, especially the tech companies, are fighting this. What do you say to the criticism that it’ll just make companies’ bottom lines look worse and that that may hit the stock price. But isn’t that a more realistic bottom line?
Naglie: Well, it’s an interesting theoretical argument, but in fact right now, companies under existing rules are obliged to make that disclosure in their notes of their financial statements.
So from a disclosure point of view, that information is out there and any informed investor can do the math quite simply, based on the information provided and ascertain what the expense is associated with the options.
The big issue however is that many observers tend to read only the headline numbers, the reported earnings of a company. And what you’re going to find is Canadian companies by virtue of having to account for stock options, are going to have smaller headline earning numbers than their counterpart companies in the States and this could very well adversely impact them in terms of their price performance in the stock market.
IC: The professional association that you’re head of, made up of senior executives, what are they saying about this?
Naglie: They are disinclined to come out individually. It’s a very, very difficult environment for corporations to speak out on any issue right now and be perceived as in any way impeding the full disclosure of information, doing anything that is deemed by the marketplace to be covering up or hiding information.
Consequently, there’s very little upside for individual companies to speak up in favour of or against any of these types of popular initiatives.
What they’re saying privately is they think that the complications involved in doing the disclosure required by the new rules put forward by the Accounting Standards Board is going to discourage them from offering options in the future.
IC: And that you think will discourage the workers needed to be attracted to these companies.
Naglie: I think certainly it puts Canadian companies at a competitive disadvantage in attracting these types of employees vis-à-vis their counterparts in the US.
IC: Will the companies be then forced to offer other kinds of incentives though to get the brains needed to move forward?
Naglie: Again, a very good theoretical solution. Unfortunately, one of the reasons that options has been such an attractive inducement to attract employees is many of these companies are start-up type companies and they aren’t in a position to offer prospective employees compensation that is going to require hard dollars.
As a result, options have provided them with an alternative that doesn’t have an impact on their immediate cash flow. Consequently, it’s tough to think of other types of compensation that wouldn’t immediately put a pinch on the very limited and scarce financial resources of start-up companies.
IC: In addition to, as you say, the trouble of attracting the right employees, is this also going to lead to more Canadian companies wanting to make a bee line to list on a US Exchange and bypass let’s say the TSX if they’re currently listed on the Venture Exchange as a tech company?
Naglie: I think that this is another encouragement, or maybe I’ll put it the other way around, it’s another discouragement to Canadian companies to list in Canada. So, yes, I do believe that certainly in those segments, in those industries that have relied and that will or would like to continue to rely on stock options as a means of incenting new employees, I think the incentive to list exclusively in the US will grow.
IC: But there is such a sensitivity to transparency in the United States. We’ve been watching a lot of gentlemen being hauled off in handcuffs. Isn’t US GAAP tougher than Canadian GAAP?
Naglie: I don’t know that it’s necessarily tougher. I think that there is a relatively high degree of congruity between Canadian and US GAAP. And quite frankly, that is the position that I think the Canadian authorities should have taken.
In other words, if in fact we are heading towards full disclosure of stock options, that’s fine. I just do not understand and I think that down the road, increasingly people are not going to understand why Canada felt it was important to get ahead of the US with respect to this matter.
This is not a horse race. There are no awards for finishing first.
I think the important thing is to bring these changes in in a way that increases a disclosure but does not adversely impact business.
And my concern is by getting ahead of the US on this particular initiative, we will adversely impact some of the most vulnerable and at the same time some of the most important sectors of our economy.
IC: You’ve mentioned that companies aren’t currently speaking out against this. Do you expect there to be more CEOs, more companies speaking out or speaking up the closer we get to the time that these rules are to be implemented?
Naglie: Yes, I think that we will see an increasing number of companies as the imminence of this particular change grows, stepping up and addressing issues related to how this is done.
Because interestingly, while the Accounting Standards Board has embraced the principle, they have not indicated the mechanic in terms of how the value will be calculated, what is going to be done with respect to outstanding options, etc.
So I think where you will see the debate focus is on the modality of introducing this particular change.
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