This morning the Financial Accounting Standards Board (FASB) released its long-awaited proposal to require companies to expense their employee stock options. By doing so, FASB hopes to close a historical loophole that allowed companies to compensate employees without recording a commensurate expense on the balance sheet.
In FASB's news release pertaining to the stock option expensing exposure draft, the board notes that it "covers a wide range of equity-based compensation arrangements. Under the Board's proposal, all forms of share-based payments to employees, including employee stock options, would be treated the same as other forms of compensation by recognizing the related cost in the income statement. The expense of the award would generally be measured at fair value at the grant date."
Sounds reasonable, right? You pay your employees, we'd like for you to tell investors what the equivalent expense would be for non-cash compensation, including options.
But what you're going to hear over the next weeks until the end of the comment period is a varying refrain that FASB is "anti-capitalist," or "wrecking the competitiveness of small companies," or "anti-shareholder," or other similar invective. Want an example? This morning the National Venture Capital Association claimed that the FASB proposal would "slam growth-oriented small businesses" and "impede entrepreneurship," and that mandatory stock-option expensing "carries a cost that is too large for the majority of small businesses to bear."
Garbage. In all of the invective, remember this: A change in measurement of a fact does not change the fact itself. If I give you $5 and tell you that it's actually $4, how much money did I give you? There's no "cost," no economic burden in showing that the $5 I gave you is worth $5. You get the idea. I wrote an article last week that deals with some of the biggest myths surrounding employee stock options.
The last time this subject was broached was 1993, when a congressional lynch mob headed by Connecticut Senator Joseph Lieberman threatened to take away FASB's status as the accounting standards setter should it go through with its proposal to require expensing. Arthur Levitt, who had just been installed as the chairman of the Securities and Exchange Commission, later called his failure to support FASB his biggest mistake as the chairman. This time around, FASB has even more firepower in its corner -- for example, all four of the big accounting firms (who one would think would be loathe to anger their option-happy clients) support FASB's independence as a standard-setting body, as does the Association of Investment Management and Research (AIMR). Warren Buffett backs expensing options, as do Senators John McCain and Carl Levin.
In some regards, though, this would have been a lower-stakes problem to solve back in 1993. In the early 1990s, stock-option expense made up about 1% of company earnings. According to a study by Standard & Poor's, after FASB backed down, the dependence upon options for compensation among America's biggest businesses skyrocketed: In 2001, earnings were overstated by 27% due to the failure of companies to expense options. That number was down in 2003, in no small part due to the decisions of hundreds of firms, from Amazon.com
The fight will be acrimonious, certainly, with stories of the entrepreneurial spirit of America hanging in the balance. I have one question: If stock options are such an integral ingredient for entrepreneurism, then how in the world did companies survive without them prior to the mid-1990s, when their usage surged? Concentrate on what's at stake: accurate, rather than optimistic, financial statements -- and ignore the tales of woe. We should be so lucky if Washington would do the same.
Bill Mann owns none of the companies mentioned in this piece. He urges you to write your senators and representative to ask that they let FASB do its job. You can find your senators here, and your representative here.