Options Expensing Debate Continues

April 5, 2004 (PLANSPONSOR.com) - The nation's accounting rulemakers may have reached closure on the subject, but controversy regarding the impact of expensing stock options continues unabated.

The latest salvo in the debate – a report from the Congressional Budget Office (CBO) – appears to lend support to the notion that recognizing employee stock options as an expense is valid from an accounting standpoint.   The report goes on to note that:

  • Not recognizing the fair value of employee stock options as an expense overstates a firm’s reported net income.
  • Changes in the value of employee stock options after they have been granted, as well as their exercise, are irrelevant to a firm’s income statement.
  • Recognizing the value of stock options is “unlikely to have a significant effect on the economy,” because the information has already been disclosed.

Congressional Opposition

The latter contention flies in the face of several in the US Congress, who have been promoting legislation designed to block, or at least blunt, the impact of a proposal issued by the Financial Accounting Standards Board (FASB) last week (see  FASB Hands Down Option Expensing Proposal ).   Representative Richard Baker (R – Louisiana) has put forth new legislation, HR 3574, that would lessen the potential impact of FASB’s proposal on corporate bottom lines by having all stock compensation granted to rank-and-file employees not counted as an expense.   House Minority Leader Nancy Pelosi (D-California) has thrown her support in with the bill (see  Pelosi Backs Executive Option Expensing Bill ).

However, the CBO report, prepared at the request of Representative Brad Sherman (D-California), directly contradicts a major concern of many employers.   “Although complicated to calculate, the fair value of employee stock options may be estimated as reliably as many other expenses,” according to the  report .   However, last year a study released by Financial Executives Research Foundation (FERF), the nonprofit research affiliate of Financial Executives International (FEI), revealed some notable differences depending on the methodology used (see  Black-Scholes Overvalues Stock Options ).

The Financial Accounting Standards Board recommended last Wednesday that US companies begin accounting for employee stock options as an expense in 2005.   Under the Exposure Draft - Share-Based Payment, an Amendment of FASB Statements No. 123 and 95 - all forms of share-based payments to employees would be treated the same as other forms of compensation by recognizing the related cost in the income statement. The expense of the award would generally be measured at fair value at the grant date, according to the proposal, which has been posted for comment through June 30 (see  FASB Hands Down Option Expensing Proposal ).

A report issued last week by Towers Perrin also indicates that the effect of expensing options has no effect on a company's stock price (see  Towers: Stock Price Unaffected By Options Expensing ).   However, it may have some impact on the breadth of stock option availability in the workplace.   A recent study found that 16 out of 100 workplaces connected to public stock market companies granted stock options in 2002 to more than half of their employees, while four of every 100 closely-held businesses gave options to most workers in 2002 (see  Study: A Fifth of Employers Used Broad-Based Options ).   Meanwhile a new Watson Wyatt survey reveals that employees at US companies discount the value of stock option grants by 30% to 50% relative to the options' actual value (see  Employees Undervalue Stock Options ).