AeA President's Message  "Stock Options Expensing: Candid Comments by Bill Archey" An Interview by Rhonda Starr,  AeA Director, Internet Communications

QUESTION: The Financial Accounting Standards Board (FASB) has voted in favor of requiring companies to expense stock options. The only thing left is how to implement this. Isn’t this fight over?

Not at all. There are two bills in the Congress, one in the House sponsored by Rep. David Dreier, a member of the Republican leadership in the House, and Anna Eshoo, the Democratic representative from Silicon Valley, and in the Senate there will be a bill sponsored by Senator John Ensign of Nevada, who is the chairman of the Republican High-Tech Task Force, and Senator Barbara Boxer, Democratic Senator from California. These bills would require the SEC to study this issue over a three-year period, study the economic impact of expensing of stock options, and look at other alternatives. In effect, it would put a hold on the FASB decision to expense stock options for at least a three-year period pending the outcome of the study.

AeA strongly endorses these bills. We are also, through our grassroots system, in the process of identifying several hundred small and medium-sized companies whose executives can weigh in with members of the Congress on this issue. We think it’s very important in the current populist atmosphere that the support of these bills is not just from the big companies. Indeed, we are also going after some private companies. A number of private companies that are seriously entertaining going public may be dissuaded from doing so if they are not able to provide stock options to their rank and file employees.

QUESTION: Why is high-tech fighting so hard on this issue of stock options expensing? It appears that in other industries, though perhaps reluctantly, there is a consensus that stock options should be expensed.

High-tech is vigorously contesting this issue because our industry, as opposed to virtually every other industry, provides stock options not just to executives, but to the rank and file employees. In a survey that we did at AeA several months ago, we found out that 84% of our public companies’ employees receive stock options and that 66% of the stock options granted by high-tech companies go to other than senior executives. Given that, the high-tech industry is disproportionately negatively affected by expensing, which would have a profoundly negative effect on the P&L statement of those companies. For other industries, because they grant stock options usually only to the senior most executives, the impact on their P&L statement is dramatically less and they, therefore, have the luxury of being able to say, okay, we’ll expense stock options. High-tech doesn’t have that luxury.

QUESTION: Isn't this pretty much a simple straightforward accounting issue? Aren’t stock options something of value that are given to executives and/or employees, which dilute shareholder value and earnings per share and, therefore, should be recorded as an expense?

No. The push to expense stock options is primarily driven by the outrage in a number of circles to the perceived excessive compensation of executives. Some of that compensation was, in fact, based on stock options and, indeed, if you look at Enron, WorldCom and perhaps some others, there were apparently some internal attempts at manipulating the stock price so as to retain the maximum value on the stock options. For some in the media, the political realm, the investment community, and the overall business community, the real issue here is the perceived excessive executive compensation, and maybe if we expense stock options, we can curb that compensation. For many, the accounting issue is secondary. The primary issue is, damn it, these folks are making too much money, let’s see if we can reduce that.

QUESTION: What’s wrong with that?

It is a non-solution to a very different problem.

QUESTION: What do you mean?

It won’t work. Expensing of stock options will make some people feel good that "they did something." But while they will not solve the problem of perceived excessive compensation for executives, they sure will hurt rank and file employees of high-tech companies’ ability to participate in the ownership of their own company, in solidifying those employees’ commitment to the company, and their desire to participate in the wealth creation of successful high-tech companies.

QUESTION: So you think FASB and others’ efforts are misguided?

Yes.

Just look at the cover story recently in Fortune magazine with the picture of the pig on the front. What that story demonstrated was that in 2002 executive compensation did not decrease and that executives received compensation in forms other than stock options. It’s interesting that every time there is an attempt to curb executive compensation, there is usually an unintended consequence which makes matters worse, depending on your point of view. For example, during the Clinton Administration, a ceiling of $1 million was put on the amount of expense that could be deducted from a company’s income taxes for executive compensation. There are many who contend that this cap is what pushed companies to provide stock options to executives in lieu of hard cash.

As the Fortune magazine article indicates, there is little doubt that arbitrary attempts to curb executive compensation will not work. The problem is that while the expensing of stock options will not reduce executive compensation, it sure as hell will reduce the rank and file employees’ compensation over time and hurt the people, in our judgment, who have been the deserved beneficiary of stock options programs.

QUESTION: I want to go back to your point that high-tech is disproportionately and negatively affected by the FASB expensing decision. Why is that?

Look, it is easy for GE, Cola-Cola and a number of other companies who have said they would expense stock options to make that decision (though how they value the options is very much up in the air). They provide stock options primarily to a small number of senior executives or managers. An Intel, a Cisco, a Sun, and many, many others provide stock options to virtually all employees. Therefore, the numbers of stock options we are talking about is immensely greater than it is for these other companies and, therefore, it is a much larger expense on the P&L statement, therefore, greatly reducing net profit. These other companies won’t take that kind of hit.

QUESTION: So, if FASB’s decision goes through, what happens to the rank and file employees?

Given the hit to their financial statement, high-tech companies will likely decide to dramatically reduce the stock options grants to rank and file employees. Companies just will not be able to afford the hit to their balance sheet. This is also why high-tech companies are fighting this issue so fiercely, because the stock options program, until very recently (where most have been underwater) has been an enormous motivator of employees and, as I said previously, has engendered greater loyalty, commitment and dedication. FASB now wants to end that.

QUESTION: Given the current atmosphere and, as you suggest, the anger about executive compensation, is there any other alternative to expensing?

Yes, and high-tech has proposed some very thoughtful, reasonable alternatives.

First, although we believe that the current requirements of FASB provide enormous information to shareholders and investors, we are willing to go beyond that. Several months ago, AeA and TechNet jointly announced that a number of our member companies have agreed to provide additional information in a very transparent manner. Among a number of commitments these companies made were the following:

1. Provide additional information in very clear, short declarative sentences on what the impact was of the stock options on the dilution of shareholder value and the impact on earnings per share. Much of this information is currently required by FASB. But the difference here is in making it straightforward what the impact is on these two issues.
2. A statement showing what percentage of the stock options went to other than senior executives of the company.
3. Identification of the allotment of stock options to the top senior executives of the company and the percentage of the stock options that went to those top executives.
4. This information would be provided not just in the annual report, but on a quarterly basis so that there would be no surprises.

The high-tech industry is eager to confront the assertion, or perhaps the accusation, that the information about stock options is buried and games are played to disguise the real scope of a stock options program. Given that we provide so many stock options to rank and file employees, we are more than willing to provide detailed information that does not require a CPA degree or a long-time career in Wall Street to understand it.

QUESTION: If FASB has made the decision that expensing of stock options should go forward, why haven’t they implemented it right away?

Because neither FASB nor anyone else that I know of knows how to accurately calculate the value of stock options at a given period of time, let alone having to do it for a three-year period. For example, what would have happened if expensing was required in 2000 when a high-tech company had to use an existing formula to value the stock option use for three years? Most of those stock options programs are underwater or are worthless at this point. But if the proposed FASB requirement had been in place, high-tech companies would have had an enormous expense hit to their P&L statement and a major reduction in profit, and yet, given the value now of those stock options, that expense was never incurred. I mean companies are being asked to play God in being able to know in the future what’s going to happen to the economy, what’s going to happen to the company, and what’s going to happen to the stock options. Current methods for valuing stock options just don’t work.

And this problem is compounded as Craig Barrett, the CEO of Intel, noted in an editorial in the Wall Street Journal recently. He noted that under the new corporate governance rules, under Sarbanes-Oxley, the CEO is going to have to certify when the company values its stock options that it is correct. Well, how does the CEO know it’s correct? Again, he’s not God.

QUESTION: Well, if this valuation issue is so complicated, why is FASB going forward?

Again, the issue is not about valuation, the issue isn’t about expensing of stock options. The issue is about perceived excessive executive compensation, and this is seen as a way to deal with that even if it isn’t.

But perhaps the rule that’s going forward is capsulized by a comment made by the head of FASB, who was being interviewed on the Kudlow & Cramer show several months ago, when he was being pushed about the problem of valuation and that there was really no accurate way to do it, his answer was "Well, what would you have us do? Would you rather us be completely wrong or at least somewhat right?"

On an issue of such import, particularly to the high-tech community and, for that matter, to the economic well being of this country, being "somewhat right" is not adequate justification for making this decision.

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This page was last updated on 05/02/03.  
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