Institutional Investors Back Option Expensing

April 7, 2004 ( - The Financial Accounting Standards Board's (FASB) proposal requiring all companies to list stock options as an expense in the income statement has broad support from institutional investors.

By a four to one margin, 302 buy side portfolio managers and research professionals surveyed by Broadgate Consultants, Inc, said they believe the FASB proposal will improve transparency in financial reporting.   Further, more than 70% said they thought the rule would improve corporate governance.

“For many years options have been silently devaluing shareholder equity. Now, the FASB is saying ‘Stop’ and institutional investors are agreeing,” Thomas Franco, Chairman and Chief Executive Officer of Broadgate Consultants said in a news release. “This survey essentially validates the market’s view that financial statements should reflect a true and accurate picture of what is occurring in a company’s performance.”

Institutional investor support for option expensing runs deep and without exception.   Nine out of 10 respondents are opposed to any exemptions from the options expensing rule for “start-ups” or technology companies, with only 6% of respondents in favor of such an exemption.

Further, more than 80% of respondents do not believe that the options expensing requirement will impair a company’s ability to attract top management talent, harm their profitability or impede their ability to attract capital.   Similarly, nearly 60% of respondents said they do not think that companies should abandon stock option plans altogether, in favor of other alternative forms of compensation, such as “stock appreciation rights.”

Overall, a majority of respondents (58%) said they are satisfied with the way the FASB went about writing the proposed rule and more than three quarters (77%) of respondents said the FASB proposal should be not be modified. Almost 85% of respondents said they were interested in the options expensing issue because GAAP accounting is an important consideration in their decision to invest.

Survey respondents were divided on what method companies should use if companies do expense options.   One-third of portfolio managers were not sure what method should be used, while another third believe the FASB recommended Binomial Lattice should be used, and 18% believe Black-Scholes, or some variation, should be used.  Among the two, the FASB said in its release of the proposal that the “better estimate” of the fair value of an employee share option may be obtained using the lattice model since it incorporates an optionee’s expected exercise andexpected post-vesting employment termination behavior, whereas a close-form model uses a single weighted-average expected option term (See   FASB Hands Down Option Expensing Proposal).