Employers Expect, But Have Reservations About, Options Expensing

September 6, 2002 (PLANSPONSOR.com) - You wouldn't know it from the string of companies falling over themselves to stake out the so-called "high ground" on options expensing - but many firms haven't made a firm decision - and a surprising number think it's a bad idea, according to a new survey.

According to a new Future of Stock Options Survey from Mercer Human Resource Consulting, just 12% of the 200 large US employer respondents say expensing is “the right thing to do,” while more than a quarter (28%) say an accounting charge for option expense is inappropriate.

Others say that options should be expensed, but only if:

  • a consistent manner is used by all companies (25%)
  • a reliable valuation method can be found (12%), or
  • the company wants a tax deduction (2%).

One-fifth (21%) have not yet taken a position on the issue.

Mandatory Movement

However, roughly 87% of the 200 large US employer respondents said they expected the mandatory shift, at least eventually.  Only 7% anticipate a change by January, but 39% expect a mandatory change by January 1, 2004 – and another 41% say it will be a reality within five years.  Just 13% say it will not become a mandatory expense.

Most (56%) of the responding firms say they are considering the potential implications, but still seem to be taking a “wait and see” approach on the issue.  Just 37% have formally considered the issue at the executive or board level.

Just one in 10 respondents (about 9%) say they will begin expensing as soon as practical, while just 5% plan to lobby actively against expense recognition.

Mercer notes that under Statement of Financial Accounting Standards 123, companies currently must disclose the fair value cost of stock option grants and the resulting pro forma impact on earnings per share in the footnotes to their annual financial statements, but they do not have to recognize that cost in their income statements. However, the Financial Accounting Standards Board (FASB) is now considering a change that would make the expensing of stock options mandatory instead of optional.

Option Impact

The survey found a wide range of potential financial impacts of expensing.  While more than a third (35%) said the magnitude would be less than 5% of earnings per share (EPS), another 28% say it would be 5%-10% of EPS.

If option expensing is required, most respondents (54%) opined that the best valuation method would be a Black-Scholes or binomial method with modifications to reflect employee stock option features, according to Mercer. One quarter (25%) did not express a preference, and 16% prefer the “real fair value” approach.

Mitigating Damage

A move to expense options would obviously impact current equity compensation programs for many.  To mitigate the impact, a third of responding employers said they would reduce the pool size (the number of options granted to employees), while a comparable 31% said they would reduce eligibility (the number of individuals who receive stock options).  Employers that estimated a higher EPS impact of the changes were considerably more inclined to reduce eligibility or grant size. 

Respondents also cited offsetting stock options with some other form of equity or non-equity compensation program (23% and 22%, respectively).