Last year, Intel (Nasdaq: INTC ) gave its employees 110 million stock options, worth $991 million (after taxes), yet this enormous and very real (though not cash) expense does not appear as a compensation expense in Intel's financial statements. Instead, it's buried deep in the footnotes of the 10-K. Were it to appear on the income statement, reported net income last year would have been 16% lower and the stock's trailing P/E ratio today would be 38.6 rather than 32.2.
Craig Barrett, Intel's CEO, in addition to his salary of $610,000 and a bonus of $1.5 million, received 1.35 million options in 2003 (131% more than the previous year), worth an estimated $14.4 million.
Knowing all of this, I'll give you three guesses where Mr. Barrett comes down on the issue of expensing stock options.
I'm sure you're shocked -- SHOCKED! -- to hear that he wants to maintain the fiction that options have no cost. As long as this remains the case, boards of directors are likely to continue doling them out to CEOs by the bushel. In addition, by reducing reported compensation expenses due to paying employees with options, companies inflate their earnings, free cash flow, return on equity, and so forth, which inflates their stock price and -- voila! -- CEOs can cash in their bushels of options at even higher prices. What a win-win (for them, anyway) situation!
Mr. Barrett and, sadly, many other similarly situated CEOs have banded together to fiercely defend the stock option gravy train because, in my opinion, they're just plain old selfish. That's why I've nicknamed them the Coalition of the Greedy. Barrett's options package isn't even that egregious relative to the option pigs in Silicon Valley: Cisco's (Nasdaq: CSCO ) John Chambers, Apple's (Nasdaq: AAPL ) Steve Jobs, and Juniper's (Nasdaq: JNPR ) Scott Kriens.
I don't lightly impugn the motives of people who, I'm sure, are otherwise honorable. But that's the only conclusion I can come to after hearing their ludicrous arguments for maintaining the status quo. Rather than calmly arguing its merits, they're paying lobbyists untold amounts (out of shareholders' pockets, no less!) and applying political pressure in other ways to intimidate the Financial Accounting Standards Board (FASB) into overturning its recommendation earlier this week. (Hey, it worked a decade ago!)
Even worse, they're engaging in fear-mongering. To see what I'm talking about, let's look at two arguments Mr. Barrett made in a recent letter to The Wall Street Journal (he also published an Op Ed in Wednesday's Journal).
(In this column, I'm not going to rehash all of the arguments for expensing options. Bill Mann covered this topic eloquently in two columns recently: The Best Stock Options Model and FASB: Ready to Rumble. And I wrote a three-part series two years ago: The Stock Option Travesty, Stock Options' Perverse Incentives, and Rebutting Stock Option Defenders.)
A boon for trial lawyers
Barrett predicts that "If expensing wins... trial lawyers will have a field day with the inaccurate methods used to account for option expensing -- how can they possibly ignore the billions of dollars of inaccurate expenses taken when stock prices don't follow expected trends? CEOs knew or should have known that their choice of option expensing algorithms were inaccurate."
This is a silly argument and a shameless attempt to exploit the likelihood that one of the few groups held in even less esteem than CEOs these days are trial lawyers.
If companies make a best-faith effort to value options and expense them accordingly, in compliance with FASB's rules, any attempt by class-action lawyers to sue would be laughed out of court. Randall Steinmeyer, a partner at Milberg Weiss, which is by far the largest shareholder class-action firm in the country, told me, "Suggesting that trial lawyers will benefit from FASB's decision to require the expensing of options is a transparent attempt to avoid the genuine issues at stake."
Of course, if companies make unsupported assumptions to deliberately understate the expense of options, thereby inflating reported earnings, they would be subject to class-action lawsuits -- as well they should be.
The Chinese Communists
Barrett also argues:
And yes, we do raise the jobs issue as part of the debate. The Chinese Communists are promoting the use of options, and not for competitors of Coke or other companies who expense options but whose options are typically given to only the top few employees, but for high-tech companies like Intel and Cisco. You can ignore this aspect if you choose, but I doubt those who do have run a company in high tech and competed with the rest of the world.
The Chinese Communists?! I feel like I'm in a 40-year time warp, but at least he forgot to say God-less Chinese Communists.
I'm not quite sure what Barrett's babbling about here, but I know fear-mongering when I see it. Reading between the lines, he appears to be saying that at precisely the time we're planning to give up our secret competitive weapon -- expense-free stock options -- those devious Chinese are adopting it so they can steal even more American jobs. What nonsense!
And you gotta love how clever he thinks the Chinese are. They're only "promoting the use of options" in domestic industries that compete against U.S. companies which give options to a broad range of employees such as "high-tech companies like Intel and Cisco." Starbucks (Nasdaq: SBUX ) , watch out!
Finally, Barrett essentially argues that those who disagree with his job-loss scenario are naïve buffoons who haven't "run a company in high tech and competed with the rest of the world." He must be forgetting about Microsoft's (Nasdaq: MSFT ) Bill Gates and Berkshire Hathaway's (NYSE: BRK.A ) (NYSE: BRK.B ) Warren Buffett. Microsoft shifted away from options toward restricted stock (and expenses both); Buffett, who runs a global company, has written persuasively in favor of expensing options.
Losing badly on the merits of the debate, these greedy, self-serving CEOs are, to their everlasting shame, resorting to bullying and fear-mongering in a desperate attempt to keep the stock option gravy train chugging merrily along. Fortunately, unlike 10 years ago, FASB and Congress appear to be standing firm.
Nearly 500 U.S. companies have voluntarily begun to report option pay as an expense, and none of the Coalition of the Greedy's predictions are coming true. Let's make this sensible change and move on to more important matters.
Whitney Tilson is a longtime guest columnist for The Motley Fool. Under no circumstances does this information represent a recommendation to buy, sell, or hold any security. He owned shares of Berkshire Hathaway and LEAP calls on Microsoft at press time, though, positions may change at any time. Mr. Tilson appreciates your feedback. To read his previous columns for The Motley Fool and other writings, visit http://www.tilsonfunds.com. The Motley Fool is investors writing for investors.