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In the debate that is going on all over the place about whether or not to expense options, one thing does not ever appear to be pointed out. Here is a relatively simple way of looking at why options should be expensed.
Let's say instead of a company issuing options to employees, they instead sold these options to the public, then used all of the proceeds to pay employees bonuses. Wouldn't all of you agree that the cash payment to the employees was an expense?
Upon the theoretical sale of the options the company would not show any revenue, it would show additional equity in the form of additional paid in capital on the balance sheet. The payment to the employees would be shown as an expense and when the company reported earnings if the market price of the stock was higher than the strike price, the options would be counted in the fully diluted earnings per share calculation. I don't think anyone who does not support expensing options would disagree with this type of scenario.
If you agree with the above premise, then why should options not be expensed if you cut out the transaction of selling the options first and instead just give the options to the employees? This is just like any other barter transaction that accounting standards dictate that you must record the full value of the barter that was given up in exchange for the services rendered or the goods received.
According to management of publicly traded companies, they are paying lower cash compensation in exchange for options being granted. If that is the case, then the expenses on the financial statements are currently understated because if you follow the logic, then that would mean that to keep these people employed, your costs are actually higher than being reported since these employees are giving up something in return for the options for their services. Therefore the expenses currently being reported are distorting the true cost of running a business.
So you see it is not as complicated as many on wall street or the press would have you believe. I feel it is rather quite simple but the FUD that is spread makes it seem that expensing options is anti-business, anti-worker, anti-American. It is just a complete crock being spread by the management and directors of most public companies that want to maintain the status quo and continue to receive exhorbitant pay packages.
Now the argument will come that companies are not allowed to sell 10 year options. In actuality a very similar situation occurs with the issuance of stock warrants. When companies raise money and attach warrants to the offering, the cash raised when used to pay salaries and bonuses, is shown as an expense and nobody says that is improper accounting. Why should options be treated any differently than any other form of compensation?
Another argument will be that what happens to options that are under water? Does the company get to show a credit for previously taken expenses? No and the reason again is simple. The granting of options is a period expense when given to the employees and should be recorded when given. Again going back to the original example, it wouldn't matter if the options were sold then the proceeds used to pay the employees, if at a later date they became worthless. You would still have incurred the expense when you paid the employees with the currency called options. The benefit that the corporation would show would be a lower number of fully diluted shares outstanding which would increase the EPS if the options are under water.
It is very easy for management of companies to twist the option debate since most don't understand how accounting really works. When it is broken down to its individual components, accounting for options is really not that difficult. As far as the valuation is concerned, there are many ways that are accepted ways of valuing options on Wall Street. I am certain that there are wall street pros on this board that could tell you the value of a 10 year option granted at today's market value. The wall street crowd can easily come up with what the worth of the options are at the time of issuance, they just don't want to because it will somehow impact their revenue in the future.
It is up to everyone to fully understand all the aspects of the options debate. Unfortunately for investors, most do not truly understand it and that is what allows the management of our companies to control the issues and spread FUD. It doesn't matter if the company is IDCC or Texas Instruments. The facts are simple, management wants to continue to misrepresent the costs associated with running businesses. Options are just another accounting gimmick that hides the true expenses. Worldcom and its executives were hiding expenses and are now being prosecuted, but for management of most other companies, they are hiding the true cost of operations and are doing so legally to the detriment of investors. Obviously what Worldcom did was illegal and the executives should be prosecuted, but what the executives at other companies are doing is very similar in the fact that they are hiding the true cost of operations.
This is going to have a huge impact on your returns if something is not done about it and soon. Please contact your congressman and tell them you are fed up with the funning accounting that has gone on for the past decade and that it is up to them to protect the investors.
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