Pros Debate Pros, Cons on Options Expensing

July 26, 2002 (PLANSPONSOR.com) - As a growing number of firms weigh in on the issue of expensing options, there appear to be widely diverging notions of the impact of such a change.

Opponents of immediate expensing got some ammunition from a new report by Bear Stearns that found that forcing companies to expense options would have represented a major drag on corporate profits last year, according to Dow Jones.

Standard and Poor’s 500 companies would have suffered about a 20% falloff in their diluted earnings per share, according to the study. That compares with 8% in 2000 and 6% in 1999.

When stock options were factored in, five companies saw year-over-year increases in operating margins turn to year-over-year declines, according to the survey. Those companies are Amgen Inc., Baxter International Inc., Nvidia Corp., St. Jude Medical Inc., and Veritas Software Co.

However, that same report offers a gleam of hope for those who are worried about absorbing the impact.  Bear Stearns & Co . accounting analyst Pat McConnell notes that, under current US accounting rules, a “transition” provision provides that ” regardless of when an entity initially adopts those provisions (fair value method), they shall be applied to all awards granted after the beginning of the fiscal year of which the recognition provisions are first applied.”

Consequently, according to a footnote in the report, “If companies either voluntarily adopt or are required to adopt the fair value method, the result may be significantly less dilutive to earnings, at least in the short term, than the footnote disclosures suggest” – essentially because, under current rules, the change would apply only to future options awards, not the billions currently resting on corporate books. 

A change in those rules is unlikely, although staffers at the Financial Accounting Standards Board, have said that a decision on how to handle such a transition will be discussed at an upcoming meeting, according to Reuters.

Even so, the impact on a company-by-company basis will be difficult for observers to assess.  A variety of methods for valuing the options have been bandied about, so even companies that embrace the change might be doing so based on different assumptions. 

And then, there is the impact on the bottom line.  In 2001, for instance, the Bear Stearns study shows a huge theoretical impact on earnings even as the cost of employee stock options actually decelerated.

In 2000, the expense of employee stock options to companies jumped 61% from the year before for S&P 500 companies, but rose only 30% last year – attributable in part to depressed profits.

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