Analyst: Small Caps Hit Hardest By Option Expensing

In fact, traditional stock option accounting in which options are not recognized as expenses pushed up small company earnings by about a third last year – much more than first estimated, Steven DeSanctis of Prudential Securities told Reuters. Not carrying the options as expenses is permitted under current rules.

Because they are often newer firms with less cash, small companies have used stock options more often than larger firms as a way to lure talent, DeSanctis told Reuters.

“Smaller companies, in an effort to hire more seasoned talent in the executive suite, may have used stock options as a way to lure these individuals,” DeSanctis told Reuters. “We expected a material impact (on financial statements), but it turned out to be even greater than we anticipated.”

Expense Overstatement

For the Standard & Poor’s 600 small cap index, stock option expense was at about $2.7 billion in 2001, representing a 35% “overstatement” in earnings for the index, higher than the estimated 31% for the large-cap S&P 500 said DeSanctis.

Small-cap companies typically have under $1.5 billion in market value.

Technology companies accounted for as much as 43% of the total option expense in the S&P small and mid-cap indexes, according to DeSanctis’ figures.

More than 96% of the 1,000 companies in the S&P small and mid-cap indices have issued stock options, with only 24 companies not having any option exposure, said DeSanctis.

“This leads us to believe that the bottom lines of small and mid-cap stocks should take a larger hit if and when stock options must be expensed,” DeSanctis told Reuters.

Standard & Poor’s, a credit rating agency, has already announced that later this year it will begin reporting company “core earnings” in which it will add in stock-option expenses to a company’s bottom line, as well as excluding companies’ pension gains, to provide a more realistic picture of earnings.