Tech Companies Resist Option Expensing

October 23, 2003 ( - As high-tech companies are running out of stock options, the stage is set for how they will defend their current practice of not expensing stock options.

Mandatory stock option expensing has been a lightning rod of controversy in the high tech industry for the past year, but the recent revelation by a Deloitte & Touche that 90% of technology companies do not currently expense stock options (See  High-Tech Companies Running Out of Stock Options ), puts looming expensing mandates high on the priority list.  

All of which came to the forefront following the April disclosure by the Financial Accounting Standards Board (FASB) that companies should be required to treat stock option grants as expenses and said a new rule could be in place by the end of 2003 (See  FASB Says Yes to Option Expensing ).     However, a reprieve of sorts was handed down earlier, when FASB pushed back the target date for issuing new rules that would force companies to expense options, now saying it does not expect to issue a proposed rule until the fourth quarter of 2004.    This came after the International Accounting Standards Board (IASB) postponed issuing its standards until the end of July 2004, after originally expecting final ruling by the end of 2003 (See  IASB Pushing Back Equity-Based Compensation Rules ).

“Public Enemy Number One”

The costs of option expensing have made the issue “public enemy Number 1 for the tech community,” said Ellie Kehmeier, deputy national tax leader for Deloitte’s Technology, Media & Telecommunications (TMT) Group and who helped oversee Deloitte’s survey of 88 privately held and 87 publicly held tech companies during July and August.   Not surprising then was that 80% of the public company respondents said the potential requirement to expense employee options is the top, or second most important issue impacting their equity compensation practices.  Potential dilution from employee stock options ranked second in public companies’ concerns, followed by the new rules giving shareholders an increased say over equity compensation matters and underwater options – options with exercise prices greater than the current stock price.

A separate study by WorldatWork found 36% would switch to restricted stock if they were forced to account for stock options as an expense (See  Microsoft Option Plan Has Little Sway ).  Other changes are also anticipated that include,   scaling back option grants,   using more cash as a reward   andshifting to other long-term incentives.   Comparatively, only 13% of those canvassed said they would not alter their current stock option plans in if option expensing becomes mandatory.

Technology companies say the potential for stock option expensing could be devastating.    A host of tech companies have come out this year with forecasts of lower earnings with mandatory stock option expensing.     Computer maker Hewlett-Packard Co. says mandatory stock option expensing would have slashed its third quarter profits 64%. (See  H-P Prints Lower Earnings Picture With Option Expensing ).  Before the   Palo Alto, California-based company came out with their numbers, NASDAQ, the primary stock exchange for technology companies, said expensing stock options could hurt small firms that do not have earnings but need to attract qualified employees as the companies in particular rely on stock options as a form of compensation. 

In addition companies such as Apple Computer (See   Apple Shareholders Vote Yes for Option Expensing), Adobe (See   Adobe Takes Snapshot of Life With Option Expensing) and Analog Devices (See Analog Shareholders Defeat Option Expensing Proposal ) have come out with amended earnings releases this year showing lowered earnings with mandated option expensing.

Real Impact

However, a Towers Perrin study handed down last year found stock option expensing has little effect on corporate bottom lines (See Expensing Options Has Little Effect On Stock Price ).  Towers concluded from that study that the economic costs of using options had been known to investors before companies began showing profit & loss (P&L) expenses.

Additionally, Buck Consultants’ study “Options Expensing: By Choice or Mandate? A Critical Question of Timing for High-Tech Companies” showed technology companies forced to adopt stock option expensing guidelines in 2004 would experience a median decrease in fiscal year 2003 earnings per share (EPS) of approximately 20 times greater than companies that voluntarily adopt these guidelines before a December 2003 deadline (See  Buck: Early Option Expensing Equals Higher EPS ).