Yesterday, the Financial Accounting Standards Board (FASB), the semi-public body whose job it is to determine accounting standards in the United States, held a contentious roundtable in Palo Alto, Calif., to discuss FASB's standing proposal to require American companies to treat stock options granted to employees as an expense. Needless to say, FASB's decision to hold the meeting in Silicon Valley, where thousands of employees count on options as part of their compensation, meant that it was wandering into the lions' den. A mile away from the site of the roundtable, technology workers held a large rally to "save" stock options. This rally was sponsored by TechNet, a group of 200 -- cough, cough -- senior executives and CEOs.
The argument to "save" stock options goes like this: Innovation is enhanced by motivation, motivation is spurred on by the chance of substantial compensation, and compensatory rewards are driven by stock options. Therefore, without stock options, innovation will die, and according to Andy Bechtolsheim, co-founder of Sun Microsystems (NASDAQ:SUNW), expensing options would move Silicon Valley backward to its history of orchards, if not the Stone Age.
Naturally, within this stream of thought, there is a massive disconnect of logic. OK, more like five massive disconnects. First, FASB isn't working to outlaw options, just to give them the accounting weight to match the economic weight that rallies such as the one attended by Bechtolsheim suggest they have. Second, the only group that is talking about the end of options in any real way includes companies such as the one Bechtolsheim founded. This logic escapes me. "Yes, it's just a change in reporting, but make us expense options, and we're going to get rid of them." Third, Silicon Valley boomed (and busted) several times in the interim between the Stone Age and the early 1990s, when stock options came into use. While I'm not opposed to hyperbole, this is a moronic comment. Fourth, there are plenty of non-cash methods that companies can use to compensate employees even if they do choose to cut back on options. Restricted stock, stock grants, and employee purchase plans all accomplish the same purpose. Know why more companies don't use them? It isn't economic; it's because of the accounting loophole that FASB is currently trying to close. And fifth, does Bechtolsheim really think that no other sort of motivation exists in the absence of stock options?
It's intellectual bankruptcy, pure and simple. Options are expensed everywhere they are used except when they come in the form of compensation. As Accounting Observer editor Jack Ciesielski pointed out to me, even Intel (NASDAQ:INTC) expenses stock options:
Fair values of cash equivalents approximate cost due to the short period of time to maturity. Fair values of short-term investments, trading assets, long-term investments, marketable strategic equity securities, certain non-marketable investments, short-term debt, long-term debt, swaps, currency forward contracts, equity options and warrants are based on quoted market prices or pricing models using current market rates. Debt securities are generally valued using discounted cash flows in a yield-curve model based on LIBOR. Equity options and warrants are priced using a Black-Scholes option pricing model. For the company's portfolio of non-marketable equity securities, management believes that the carrying value of the portfolio approximates the fair value at December 27, 2003, and December 28, 2002. This estimate takes into account the decline of the equity and venture capital markets over the last few years, the impairment analyses performed and the impairments recorded during 2003 and 2002. (2003 10-K, p. 57)
Apple (NASDAQ:AAPL) made an acquisition using options. Should we assume that the sellers, therefore, gave Apple their company for free? No, that's ridiculous, and as a matter of fact, Apple expensed these options, as it was required to do. This is a loophole, folks. A contentious one to be sure, but one that lowers the level of disclosure to the owners of these companies.
My favorite line from the rally, though, came from Sun employee Upendra Brahme, who stated of FASB that "they should stay out of this." It's a fairly bold assertion that the accounting standard setters should "stay out of" accounting, but while we can forgive Brahme his ignorance, we can also note the parallels between this crude argument and the ones being made throughout the Valley, and by its elected representatives.
Of course, since options expensing looks to be very likely, Silicon Valley doesn't have much to lose by throwing a fit. If it wins, it works out great; if not, it gets all sorts of "I told you so" excuses for years to come. And people will probably buy it, too, as long as they're unclear on the fact that we're just talking about an accounting entry. That's the point of the carping about, to scare people to death about the economic consequences of something that isn't economic in the first place. That's why Qualcomm's (NASDAQ:QCOM) chief financial officer tries to argue that his company would have been viewed as a "miserable failure" had options been expensed -- he hopes that he'll scare shareholders into supporting being given information of lower quality. After all, if the results turn out looking better, we can just have A Prairie Home Companion kind of market, where all companies are above average. It's why Intel's Craig Barrett is willing to play the "threat from China" card. It's why they keep the focus not on more robust information, but on the threat of grievous financial loss. I really didn't realize that we were all eating berries and bark before stock options came along, but apparently this is the case.
So by all means let's keep the accounting experts away from making accounting decisions. I'd also like to suggest that engineers and architects be kept far, far away from the next bridge that goes up in Silicon Valley. After all, these are economic, not structural, concerns, right? No, wouldn't want the experts involved.
Those in Congress may pass any laws they wish, but they're not creating an iota more of actual value at companies that refuse to expense stock options. They're doing nothing more than pitting the interests of the few (technology workers) against the interests of the many (91 million shareholders in the U.S.). The Silicon Valley employees' response is logical, even if it is intellectually dishonest. They are interested in keeping the gravy train going. The employers have threatened to cease granting options should a reporting methodology be changed. Therefore, the employees are opposed to the change in the methodology, claiming that the dispassionate change is actually an assault by the governing body against their own livelihoods.
Given that self-interest, it is a natural, if poorly reasoned, conclusion. It is also wrong. Please, write your senators and representatives and tell them so.
Bill Mann does not (and will not) own shares of companies mentioned in this article. He is a member of the User's Advisory Council of the Financial Accounting Standards Board. Yep, we do have plenty of companies we like -- take a look at what Mathew Emmert's got cookin' with a free trial to Motley Fool's Income Investor.
