Editors' note: An earlier version of this article implied that Level 3 Communications and Nortel Networks were among those companies opposed to options expensing. In fact, the two already expense their options. We regret the error.
California is an amazing place. It seems peaceful and beautiful on the surface, but it's full of creepy dangers, kind of like David Lynch's Main Street, USA, or a Hieronymus Bosch painting.
This is a state that knows no bounds when it comes to protecting the helpless little guy. In California, they hire feng shui consultants to make sure public buildings face the right way, so that the little guy doesn't suffer from bad vibes. In California, packages of jig-headed fishhooks carry a statement warning you that it would be unwise to eat them because the fishhooks might give you lead poisoning.
Given this impressive atmosphere of paternalistic protectionism, you might think that influential Californians would take a strong stand and stick up for measures to protect some of the most important little people in this country -- the millions of public shareholders who put the capital in capitalism.
Unfortunately, if you ask these influential Californians, "Should we give investors timely, accurate information on real costs to their companies, like stock options?" the answer will be, "Of course not! The truth is too dangerous. And by the way, stand here, face west, and don't eat those fishhooks. They might be poisonous."
California, of course, is home to the tech industry, center of the coalition of the greedy. Options-happy CEOs like Intel's
Anna Eshoo, bad for you
One of the loudest voices in this choir is Rep. Eshoo. She's been beating her drum for years and proudly notes that her very first bill, way back in 1993, addressed this issue. (Awwww.) Too bad she's had it wrong for so long. Eshoo continues to argue that expensing options is the same as taking them away. Many Fools have rebutted this notion time and time again. It comes down to this: Options have a real cost, far beyond the simple dilutive effect. Some of us -- and we're often called "commie/pinko/morons" for taking this position -- think that real cost should be expensed right up there on the financial statements, not hidden in the footnotes, where corporations can pretend it doesn't really matter. We're not opposed to option compensation. We just want it out in the open, a position held by no less a capitalist than Warren Buffett, which makes him, by my tally, the world's richest commie/pinko/moron.
(By the way, for those of you who continue to protest that options don't, in fact, have a cost, I repeat a challenge my colleague Bill Mann has also made: Send me all the options you've got. Underwater, I don't care. In return, I'll send you nothing, exactly what you claim they're worth.)
Although Eshoo (Gesundhiet!) has worked hard to strike a "laissez-faire," pro-business pose, she's really just shilling for her Bay-area constituency. Let's be realistic. We can expect nothing more from someone who is forced to compete for her job every few years in a public popularity contest. If you want to know whom she answers to, click here to take a look at some of Eshoo's sponsors, which include Sun Microsystems
Unless you're made of pretty stern moral fiber, you'd pander. You'd pander a lot. You might, for instance, introduce a bill with the misleading name of "The Broad-Based Stock Option Plan Transparency Act," as Eshoo did one month ago, and claim you're doing it in the interests of economic good.
If truth were required in legislative titles, Eshoo would have been forced to call it the "Stock Option Obfuscation and Independent Auditor Emasculation Act," since the aim is quite clearly to provide less transparency for shareholders, as well as forever shackle U.S. accounting standards to the partisan bickerers in Congress.
As before, Eshoo is working hard to keep full and timely information from investors. Though Senate Banking Committee Chair Richard Shelby (R. Ala.) has stymied these attempts in the past, Eshoo continues to shovel the same old. shtick. Yes, that's the word. Her bill would "summarize," whatever that means, the options given to top management, and it would require a "plain English" explanation of dilution -- a nice "feel-good" touch, except that dilution is only one of the costs of stock options. The lack of a "plain English" explanation of that point makes it clear that Eshoo's aim isn't just to keep the status quo, it's to let corporations tell even bigger whoppers and divert attention from the fact with a little bit of ostensibly educational sleight-of-hand.
"See, Jimmy! Here's what dilution means. Can you say that big word? Die-looo-shun. What's that, Jimmy? You want to know what it's going to cost Apple
The only new maneuver in Eshoo's bill is so amateurish that it might have been taken straight from the Legislative Obstructionist's Handbook -- the one they give incoming representatives when they get off the plane at Reagan National Airport, with a gleam in their eyes and a stem of grass in their teeth. Eshoo wants to mandate a three-year "study" before implementing the rules.
I got your study right here, Anna
Eschoo has claimed, "Stock options have become associated with corporate scandals and excessive executive compensation, leading to a call for expensing as the ultimate prescription for these problems. But stock options were not the cause of the corporate accounting scandals, and eliminating stock options would do nothing to instill corporate responsibility or accountability."
She may be wrong on that one. In fact, a recent study titled "Is There a Dark Side to Incentive Compensation?" by David Denis, Paul Hanouna (Purdue University), and Atulya Sarin (Santa Clara University), suggests exactly the opposite.
Before we begin, let me acknowledge that I haven't met these researchers. Jeff Mahoney at FASB forwarded their study to me via email, so I can't eliminate the possibility that this trio might be part of our vast commie/pinko/moron conspiracy. I will note that if they are, they are being clever enough to deny it.
As they expressly state in their paper, "We caution that our findings should not be interpreted as an overall indictment of the use of equity incentives in executive compensation plans.. Our findings imply that these benefits of equity-based compensation must be balanced against the potential costs of increasing the incentive to commit fraud."
What are those findings? The more that CEO pay depended on options, the more likely a company was to cook the books to some degree, or at least be hit with allegations of that behavior. Comparing 358 companies that were subject to fraud allegations and 358 substantially similar companies that were not, the team found a positive, statistically significant relationship between fraudulent financial reporting and the degree to which CEO compensation is linked to stock options. They also found that higher levels of institutional ownership exacerbated the problem, and, contrary to their hypothesis, there was no evidence that things were any better at firms with a greater number of outsiders on their boards.
In other words, the options themselves are the problem. The more your pay depends on your share price, the more aggressive you're going to be about managing your earnings to meet and beat the Street's expectations, so that you can maximize the share price, and your payoff. It would be nice to know if there were less fraud at companies that expense their options, but given that so few of them do this, there's probably no way to come up with large enough samples to come to conclusions of any statistical significance. Either way, I don't see how anyone could seriously argue that less information would make things better.
You want who to do your bookkeeping?
By far the most dangerous bit of Eshoo's bill is her continued attempt to introduce congressional meddling into the nation's generally accepted accounting rules. Is there a group of people less suited to matters of fiscal responsibility than our politicians in Washington? Just yesterday, the Senate voted to book billions of dollars in tax revenue from a project that does not and may never exist -- oil drilling in the Arctic National Wildlife Refuge. Just weeks before, I watched as a Senate budgeting committee voted to exclude from the budget a very real, present cash outflow -- the costs of maintaining our military presence in Iraq.
Are these the people you want to put in charge of the accounting rules for corporate America? A group of yahoos who see no problem in spending pretend money, while utterly ignoring real expenses?
Turning from congressional math impairment, it should be obvious that this would set an amazingly dangerous precedent. If the legislators start writing the rules, where will they stop? And who do you think will be doing the actual rulemaking? Think it might end up being corporations and lobbyists? I'm sure they'd love to buy their way out of all sorts of annoying accounting rules. Why expense options given out in lieu of cash payments for rent and services? Why bother expensing cash given out as payment for goods?
Think that couldn't happen? You need to watch more C-SPAN.
Remember, our stock markets depend on confidence in the clarity and accuracy of our firms' earnings reports. If you consider that investors -- especially foreigners -- are already biting their nails over our country's amazing deficits, how do you think they'll respond if the folks who bring us that red ink start dictating how corporations do their books?
I know I'd be much more inclined to stuff extra cash into my sock drawer. If everyone else did the same, things would get real ugly, real fast. And if a crisis in confidence leads to a market crash, those precious stock options will become worthless. And none of us wants that.
For related Foolishness
- Check out the coalition of the greedy.
- What's The Best Stock Options Model?
- Is FASB still ready to rumble?
Seth Jayson would love to have Rep. Eshoo over to Old Town for a lunchtime discussion of her legislation. At the time of publication, he had positions in no company mentioned. View his stock holdings and Fool profile here. Fool rules are here.
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