Piper Cole's Weblog

I Hate to Say We Told You So, But...

Last week Business Week, one of the financial press that supported requiring businesses to expense stock options, ran an editorial that began: "What have we wrought? Expensing stock options was supposed to provide a clear, consistent picture of earnings that can be compared across companies and industries. But that goal may now be fading." The gist of the editorial is that with the lack of agreement on any accurate method for valuing stock options, and the lack of guidance from FASB because they can't find an accurate valuation method,  investors aren't getting any better information as a result of expensing.  This is what industry has been saying all along.  Valuation of stock options is not just difficult, it's a shot in the dark, and a mere fraction of a difference in your aim will result in a widely dispersed shot group.

So if you don't have better investor information, then what do you have as a result of expensing? Do you have lower executive compensation? Not likely. There is still a competitive market for good executive talent, and having your executive compensation tied to the same metrics that affect a shareholders investment is still a good thing. But the real issue is the workforce. Sun distributes their stock options broadly within the company--over the last 5 years over 87% of the options have gone to rank and file employees below the VP level. It's these employees who are likely to be hurt by FASB's requirements, because even though there is no consistent expensing method, and therefore no comparability, any expensing method is likely to be expensive for the company--too expensive to continue the practice.

And then who loses?  The rank and file employees who won't get the same ownership incentive; the investor, who won't see the results of a motivated workforce of owners who are working for more than a salary, they're working to increase the value of the company; and finally the economy, because innovation, and with it competitiveness, comes from people who have a stake in the results.  And all of this is happening at a time when China and Taiwan have discovered the powerful motivator that stock options can be, and are luring away the most talented scientists and engineers.

So let's balance this out: one the one hand, even Business Week admits that there is no increased clarity for the investor; one the other hand we are losing competitiveness in the world market.

At this point, FASB has spoken. But there is still time for the SEC to weigh in and select a valuation method that will do two important things:  1)provide comparability for financial statements so that investors do have some useful information, and 2)provide a reasonable approach that won't destroy the ability of companies to continue their broad-based stock option plans, and offer the incentive of ownership to their employees.