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As Congress departed after finishing its business for the year, another issue was playing out behind the scenes in government and on Wall Street that could have even further-reaching implications for investors and corporations.
Recently, the Financial Accounting Standards Board issued a rule requiring corporations to report the issuance of stock options as an expense beginning in the third quarter of 2005. FASB is to be commended for having the courage to take a look at the thorny question of stock options.
However, if they are to provide real clarity to investors, their inquiry must get past the issue of "expensing" and examine what stock options truly mean to the shareholders and to the bottom line.
The financial impact stemming from the issuance of stock options cannot be simply classified as a cost to a corporation. Those in favor of expensing argue that options represent a cost to the corporation because the company has forgone the opportunity of selling the stock on the open market. However, opportunity costs are not genuine accounting costs when it comes to measuring the financial performance of a company, because they do not subtract from realized gain.
Conversely, options do provide a benefit to the corporation by allowing it to retain extra cash that would otherwise be used for salaries. Options also yield a direct financial benefit when employees pay cash to the company to exercise them. These fundamental points make expensing or not expensing options irrelevant, as neither provides the full picture to the investor.
These cash benefits of stock options to the corporation are not taken into account under the current accounting requirement. Nor will they be taken into account under the proposed rule.
Some portfolio managers believe that they enjoy an advantage over competitors because they actually understand the economics of employee stock options, while other experts and investors do not. It is time that FASB and the securities and Exchange Commission act...