A couple of big issues are coming up this week. Interestingly, they both have to do with accounting. It's not often that accounting issues get people into a lather, but this is one of those times. Well, it oughta be, at least. Prepare to be dazzled by the eyeshade crowd. I hope "dazzled" is the right word. At this point, individual investors darn well deserve some good treatment from the folks who are charged with presenting accurate financial pictures of public corporations.
The chairman's seat is getting cold
I received a request yesterday from the Securities and Exchange Commission. They are looking for candidates for the chairmanship of the Public Company Accounting Oversight Board, and asked me to contribute some names. In all honesty, they asked you to contribute. I am quite happy to oblige. As we all remember, the first chairman, William Webster, lasted only a few days in his position after it was discovered that he served on the auditing committee at a company that dismissed its outside accountants when they asked some pointed questions -- one that is now in bankruptcy and drowning in shareholder lawsuits. Then-SEC Chairman Harvey Pitt consequently lost his job for his role in covering up Webster's checkered history of corporate governance.
My nomination for this position is the same as it was back in October: former TIAA-CREF Chairman John Biggs. He apparently had the inside track for the chairmanship until either (a) some folks at the SEC didn't like his aggressive lobbying for the position, or (b) the auditors lobbied hard for Webster instead. Maybe it was both. Now that Webster's record of favoring -- ahem! -- flexible accounting is in plain view, his popularity among auditing companies makes some sense.
Biggs, on the other hand, scares the fire out of people who have had a field day with the laissez-faire accounting oversight that has taken place since 1993 (more on this in a bit). And rightfully so. I'll reprise the comments I made about Biggs back in October:
[TIAA-CREF's] principle-based investment criteria sprang largely from its chairman of 13 years, John H. Biggs, who is retiring this year... Accounting firms have complained to lawmakers that they fear Biggs will impose restrictions on auditors that go beyond changes called for by the legislation. Many corporations are also afraid that Biggs will push for stiffer accounting on stock options, like the ones he supported this past month as a member of the Conference Board (.pdf file).
And these entities are right to be concerned; that is what he'd do. However, they seem oblivious to the possibility that, in the long run, they'd be better off with a John Biggs watching the store.
There is a truism that, even in a demonstrably broken system, there are people whose interests lie in maintaining the status quo. The U.S. stock markets are far from broken, and yet investor confidence is at a low point.
We can point to the pop of the technology bubble as a reason, but there is much more. Coziness between auditors and corporate managements, deadbeat boards of directors, absurd executive compensation, dirty investment banks, and the bastardizing of professional standards are conspiring to destroy our markets. Until these issues are addressed, there will be no rebound in the stock market.
It's been four months since Webster stepped down. Only in the past few weeks has a new SEC chairman been appointed, William Donaldson. Mr. Donaldson has, right in front of him, the ideal candidate to help restore investor faith in the stock market. His name is John Biggs. But perhaps the Fool Community has different people in mind. Let us know!
The stock options thrombo is on
Ten years after the Senate, led by Connecticut Democrat Joseph Lieberman, voted 88-9 against the recommendation of the Financial Accounting Standards Board (FASB) to require companies to expense options, the FASB is bringing the issue back. This was a substantial victory for the folks who thought expensing was a bad idea. But there was a problem -- the Senate shouldn't have had its mitts on the issue to start with. The FASB, as I described recently, is an independent body so that it can (if it deems necessary) make unpopular decisions that benefit society. Then-SEC Chairman Arthur Levitt failed to stand up for the FASB's independence in this issue, and the FASB caved. Later, he would describe this as the single act he most regretted during his time as chairman.
Instead of requiring options expensing, the FASB declared it to be "accounting best practices," but optional. Guess how many companies jumped all over that particular offer? Out of the S&P 500 companies, there were two: Boeing (NYSE:BA) and Winn-Dixie (NYSE:WIN). These companies ought to get plaques or something. Beyond that, the sound you heard through the remainder of the 1990s was the vacuuming of cheap shares granted to employees in large batches. At some firms, the amount of dilution was astronomical. Further, with both the FASB and the SEC on notice that the Senate sugar daddies would come in and stand up for corporations, accounting practices plummeted even as reported profits soared.
By 2001, we had an enormous intractable mess on our hands. There were companies with massive overhangs of options and billions in debt (some of it hidden). In the collapse that followed, some semblance of rationality returned. Irate shareholders tipped the hands of corporations, and many have rushed back toward the fold of providing good accounting. Around 200 companies have decided in the past year that they would voluntarily expense stock options as well, including Coca-Cola (NYSE:KO), Costco (NASDAQ:COST), and even Amazon.com (NASDAQ:AMZN). While this is an increase of 10,000% from the previous year, 200 companies out of 9,000 is still not very many.
A decade after the first FASB decision, the accounting board is at it again. Today, the FASB is expected to discuss how to value employee stock options. The board has a little more cover this time around, though there are 15 senators, this time led by Wyoming Republican Mike Enzi, who is an accountant by training. This time, it has a mandate to coordinate U.S. accounting policy with the International Accounting Standard (IAS), which has already adopted expensing.
It's a pretty sure shot that the FASB will reopen the subject. The process that would follow such a decision will be in the form of a "project" of stock-based compensation on the FASB's rule-making program. You can fully expect that once this happens, the gloves will come off and you will see executives come out of the woodwork to claim that stock options drive American prosperity, built shareholder wealth, steered the Mayflower, invented the Post-It, and once won the Kentucky Derby. By contrast, expensing options will cause economic turmoil, cost companies millions, cut off employees from ownership, re-ignite a return to Communism, and cause gingivitis, shingles, and bad fashion sense.
All of this (well, except for the fashion thing) is total garbage. When the bellyaching and hair rending starts, just keep repeating to yourself:
"The economic cost of expensing stock options is zero."
That's it. So, when you hear that expensing options would "cost" Intel (NASDAQ:INTC) $1.1 billion out of the $3.2 billion that it earned in 2002, recognize that this is bogus. The reported number would be lower, Intel's economic results would be the same.
There are plenty of arguments against expensing options. Some have validity, including the fact that the methods of expensing are inexact. However, as I noted on Monday, it's not like this is a limiting factor for other areas of GAAP, such as pensions, where General Electric (NYSE:GE) was able to count earnings from pensions of $800 million even though the pension actually lost more than $5 billion. As Nobel Prize-winning economist Robert Merton stated in an article published in the Harvard Business Review: "What's the point of trying to get one entry in the income statement precisely accurate if all the other entries are not?"
Indeed. For years, the FASB has already labeled expensing stock options as accounting best practices. There's a reason, then, that ignoring this directive is adopting "somewhat less-than-best practices." Get ready to be dazzled by accounting. It may seem dreary, but I assure you that the outcome is quite important. Another loss by the FASB, or another intervention by Congress, and I fear that it will be a long time before the American public markets are anything but a rigged game.
Fool on.
Bill Mann, TMFOtter on the Fool Discussion Boards.
Bill Mann's faith in college basketball was restored last evening while watching IUPUI's coach Ron Hunter do something akin to breaststroke at midcourt, after his team secured its first-ever bid to the NCAA tournament. Bill owns shares of Costco. He is senior editor of The Motley Fool Select, where you can find his best Foolish stock ideas that you won't find anywhere else. The Fool is investorswriting for investors.
