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San Antonio Express-News

To expense or not to expense?

The debate over stock options still rages in boardrooms.

July 26, 2003, Saturday , METRO


LENGTH: 692 words

BYLINE: Analisa Nazareno

Stock options are under the red-hot scrutiny of activists calling for corporate accounting reform these days.

Options' use by companies dilutes the value of a company's assets, obfuscates real expenses, and hides the true value of compensation packages awarded to executives, accountants and pension protection advocates argue.

And while the Federal Accounting Standards Board to date hasn't taken official action, observers say it's just a matter of time before the deliberative rule-making body requires companies to report stock options as actual expenses, rather than in the tiny font footnotes of their earnings reports.

"I see that now more than any time in the past five to six years, the movement towards expensing stock options has gotten stronger and is likely to succeed," said Steven Huddart, associate professor of accounting at the Smeal College of Business at Penn State University. "If I had to guess as to when it would become part of GAAP (the Generally Accepted Accounting Principles) I would say that would be within five years."

The current environment of skepticism and disdain towards Wall Street in the wake of corporate scandals has made the ground for such accounting reform more fertile, he said.

"It takes a long time for FASB to do stuff," Huddart added, about why such action has yet to happen. "They need time for comment, etc. It's an open process of debate that goes into adopting these financial standards.

"But it ought to happen, because implicitly what's going on now is that people are saying that the value of stock options is zero. And zero is not the right number."

Stock-based compensation is as relevant as employee cash compensation, monthly cash flow, and sales, he said, in the valuation of a company's worth.

Companies issue stock options - rather than buying stocks and giving them to executives and employees - because they have a tax advantage and an advantage in earnings reports to do so, argued Charles Robinson, a co-founder of San Antonio-based money management firm, Robinson & Wilkes Ltd.

"Without an accounting for the numbers of options, managers have a tax reason to do more (options) and no reason to do less," Robinson said. "There's just no incentive for management to reduce the issuance of employee options. It needs to be in the accounting."

Because they aren't required to include options as expenses in their earnings reports, he said, companies are allowed to give the impression that their profits are greater than they actually are.

Currently, FASB requires companies to state stock options issuance in the fine-print footnotes of their annual reports.

Baltimore-based accountant Jack Ciesielski combed through corporate financial statements, reading the footnotes to ascertain the stated value of stock options. He adjusted net earnings accordingly in a report on stock compensation.

According to his calculations, stock options diminished the true net earnings of S&P 500 companies by 23 percent - or $47.6 billion - in 2002. The expenses from this category of "unrecorded compensation," he wrote, grew at an average rate of about 58 percent each year over a six-year period.

While Ciesielski makes a good argument for reform, any such adjustments to GAAP are likely to have little effect on companies' ethical or unethical behavior, said Gerald Garvey, an associate professor of financial management at the Drucker School of Management at Claremont Graduate University.

"You should be aware that there is always going to be manipulation in the earnings reports," said Garvey, whose expertise includes the effectiveness of employee incentive programs and the effect of such programs on stock valuation.

Garvey said there's little that FASB can do to protect investors from being duped by corporations, whose executives and employees might have an incentive to drive the stock prices.

"There are lot of stupid business decisions made to manipulate earnings," he said. "A healthy distrust of earnings reports is a good thing."

San Antonio Express-News (Texas) July 26, 2003, Saturday

GRAPHIC: PHOTO: BLOOMBERG FILE PHOTO : Craig Barrett, chief executive officer of Intel Corp., has argued against treating stock options as a compensation cost and has said that the Federal Accounting Standards Board, the U.S. accounting rulemaking body, is set on forcing companies to do so.

LOAD-DATE: July 30, 2003

Copyright 2003 San Antonio Express-News

Steven Huddart
Smeal College of Business, Penn State University, University Park, PA 16802-3603 USA
(814) 863-0048
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