FOOL ON THE HILL
Are We Angry? You Bet.

We received a trade association press release Friday, hailing the defeat of Sen. McCain's "assault on stock options," calling it a "bipartisan effort in support of high-tech workers." A bipartisan assault on investors is more like it. No one on Capitol Hill seems to understand that accounting for stock options has exactly zero economic effect on a company. What they're supporting is not high-tech workers, but corporate greed and a touch of blackmail. Bill Mann's coming out swinging.

Format for Printing

Format for printing

Request Reprints

Reuse/Reprint

By Bill Mann (TMF Otter)
July 16, 2002

I hope by the end of this effort, Taryn Lynds, director of public communications with the American Electronics Association (AeA), wishes she had never heard of me, or The Motley Fool. I know she's going to rue sending us a copy of a press release hailing the defeat of accounting stock options.

AeA is comprised of more than 2,700 high-tech company members. These members make up an enormous slice of the American economy, including such massive beasts as Microsoft (Nasdaq: MSFT), AOL Time Warner (NYSE: AOL), and Cisco (Nasdaq: CSCO). Among its members are the worst abusers of stock options grants in the market, with companies that routinely give away hundreds of millions of shareholder value to insiders as performance-based incentives.

This is not an effort to get companies to rein in executive compensation. I'm not a big political animal, and I'm certainly not one to stoke the flames of class warfare. If they want to pay executives millions of dollars, and the shareholders approve, well, by all means, they should. But as an individual investor, I find the arguments against stock options accounting so disingenuous that I can't understand how people don't see them for what they are: self-interested ways to give insiders enormous pay packages without disclosing the effect to shareholders.

Seriously, these options are worth billions to those who receive them. Not expensing them treats the options as if they've come out of thin air. Someone bears a cost, and that cost should be represented. That someone is the existing shareholder.

For the last time (which means that it won't be for the last time): Options expensing has no economic effect! The cost to shareholders -- in the form of dilution -- is exactly the same, either way. Companies are trying to make their income statements look as good as possible. Congressmen: AeA's arguments supporting high-tech workers in regard to stock options are snow jobs. Companies are afraid that if they have to show the true economic cost of options, earnings will be lower, and their share prices will drop.

Big deal! If stock options provide a distorted picture of performance to the end shareholder, then we're not talking about making financial statements look worse. We're talking about making them look accurate. Where else could you say, "Well, if we lie, it looks better..."?

Oh yeah, Washington. Never mind.

Ah, but what about the rank-and-file employees of these companies? Some companies say that these employees will be denied a valuable form of compensation if the company expenses options. Read that paragraph above once again. Options expensing has no economic effect. So, if a company is going to take options away just because it has to expense them, it's saying, "It's OK to do so, as long as we don't have to tell people the cost...." That's not an argument based on the righteousness of the cause. There's a word for companies that curtail options to the rank and file, simply because of expensing: blackmail.

Earnings presented to shareholders that do not include stock options expensing are deceptively high because they overstate the amount of economic return an investor should expect. Coca-Cola (NYSE: KO) finally gets it. So does The Washington Post Co. (NYSE: WPO). Winn-Dixie (NYSE: WIN) and Boeing (NYSE: BA) have understood this for years. Warren Buffett has understood it for years, calling the current treatment of stock options "absurd." Ah, but the AeA felt good enough about itself to declare "victory."

When the AeA 'won,' shareholders lost
The victory the AeA claims, dear shareholder, is over you. And if you own shares in a company in the AeA, the company is paying dues to an organization that's fighting your interest in determining the true cost of a company's employee compensation. One would think that a trade association representing so many public companies would be more careful than to poke the hornet's nest of angry shareholders.

I have crafted a letter of response to Taryn Lynds of the AeA, expressing my displeasure at its self-interest and anti-shareholder stand on stock options. I pointed out that among AeA's members are the worst abusers of stock options: companies that give mega-grants to executives, that give away 8%, 9%, 10% per year to employees. This, by the way, is the same organization that lobbied hard against stock option expensing last time around (thank you, Sen. Joe Lieberman), and vociferously fought the Financial Accounting Standards Board's banning of pooling interest accounting methods for acquisitions, claiming that it would be disastrous for the technology industry. Guess what? All of those acquisitions used a pooling method that turned out to be a basket of snakes.

But the current turmoil and shareholder anger offer individual investors an opportunity to say to public companies, "Enough is enough. You can hide compensation costs to shareholders, but we refuse to be among them." AeA and other lobbying firms have held sway in Washington forever, and they will continue to. But in order for their plots to keep stock options hidden to be successful, they need individual investors to play along. Well, I won't.

I control The Rule Maker Portfolio. Tomorrow, we're selling one company in the portfolio, an AeA member. In the next few weeks, we will continue to purge AeA member companies from the portfolio. I'm also going to sell the stock of AeA members out of my own portfolio. With each sale, I'm going to send a brief letter to the company's investor relations department. It will say:

Dear Sir/Ma'am:

It is with some regret that I inform you of my intention to sell my entire position in your stock. I don't doubt that yours is a fine company. I would not have invested otherwise. However, I am appalled by the position the AeA, a trade association to which your company belongs, has taken in regard to employee stock options expensing. My investment dollars support you, and, in a small way, those dollars are paid to an organization that holds my right to proper accounting of compensation in contempt.

Your continued membership in and support of the policies of the AeA reveals the level of contempt in which you hold shareholders. Until your company either leaves the AeA or enacts a shareholder-friendly employee stock options policy, which includes expensing, you should expect me to continue on my campaign of getting others to sell your stock.

Sincerely,
Bill Mann

Companies eager to hide stock option compensation expenses in fear of a stock sell-off can't be pleased by a sell-off of their shares as a result of their failure to give owners proper accounting. Care to join me? Here are lists of every publicly traded company that is a member of the AeA: Group 1, Group 2, Group 3.

While you're at it, why don't you send a note to your senators and representatives, telling them about what you're doing?

I have no ill will toward these companies, nor do I find it particularly pleasant to sell things that I may not wish to sell. Doesn't matter. This is right. Do you hear me, AeA? You may have the big money, but in this matter, you are in the wrong.

Fool on!
Bill Mann, TMFOtter on the Fool Discussion Boards

Bill Mann is senior editor for investing at the Motley Fool. He's also, in spite of the sentiment put forth here, a net buyer of stocks at this time. He has beneficial interest in Cisco. The Motley Fool has a disclosure policy.