Back to accounting basics

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					BUSINESS DAY, JULY 22 2002 THE BOTTOM LINE
Back to accounting basics

IT WILL be a long, uphill struggle, writes the Financial Times' Lex, but parts of corporate America are trying to win back the moral high ground. Coca-Cola's decision to expense stock options on the ledger is a bold attempt to grab the initiative on accounting reform, just when legislators are on the warpath and too much of the US business community is circling the wagons. The hand of Warren Buffett, as a Coke director, can be detected clearly. But there is also an element of "jump before you are pushed". A host of proposals on accounting reform is likely to be tied up in congress, and regulators' offices, for too long to make a swift effect on the sense of mistrust in investors' minds. Sensibly, Coca-Cola appears to realise that transparency is at a premium and there may be a corporate governance bonus awarded to first movers. But such efforts could be undermined by ferocious opposition in some US business quarters. If the cost of stock options is so adequately reflected in accounting footnotes why do these lobbyists kick up such a fuss about their effect on the profit or loss being spelled out? Clearly, they feel there is something to be gained in obscurity.

There is more than one sensible way to value stock options, but Coke has set a worthy precedent by letting the market decide. Expensing stock options will affect reported profits and multiples Standard & Poor's estimates that such a move, which it supports, would have cut operating profits in the S&P 500 by between 10% and 15% last year. But now is a good time to bring accounting back to earth. Weigh up the options WHETHER Coca-Cola's move is the start of a global trend remains to be seen, although the signs are promising. Coke is in fact not the first US company to expense stock options Boeing has been doing so for some time and such highprofile capitulation to investors' demands has a way of building up momentum, a phenomenon Frater Asset Management chief investment officer Terence Craig refers to as a "ground swell of peer pressure". And let there be no doubt that expensing options is what institutional investors want. The latest McKinsey survey found that 83% of respondents worldwide were in favour, although the proportion only just exceeded two thirds in the US.

Yet SA is far more closely aligned to European thinking on such matters, and there the positive response was 98%. The same survey found that institutional investors were prepared to pay a significant premium for shares in companies with good corporate governance. This ranged from 11% for companies domiciled in "clean" countries such as Canada to more than 40% for some emerging markets. The premium quoted for SA was 22% recognition, perhaps, of regulators' efforts to rid the JSE Securities Exchange SA of its mining camp mentality, and the effect of the King committee's recommendations. However, treating share options as the expense they clearly are is no panacea to the current crisis of confidence that has been gripping world markets. What is needed is a genuine commitment to complete transparency when it comes to directors' remuneration. That means not only showing how overgenerous share incentive schemes dilute other shareholders' stakes, but also divulging the criteria used to determine when individuals should earn such allocations. If share options are to be considered an incentive, it also implies that they will not be issued at a deep discount, which puts holders in the money before they have lifted a finger to enhance shareholder value. Nor should they be repriced if the share tanks, whatever the cause.

None of the criticisms of the way share options have been abused in the past means they are bad per se, just that they are not the be-all and end-all of remuneration best practice. Frater, which pioneered the "engagement" brand of shareholder activism in SA through its style of managing the socially responsible Earth Equity Fund, advocates that the bulk of payments to directors be in the form of traditional monthly salaries, with incentives such as share options used to reward outperformance. It is clear that SA's companies, and especially those with secondary listings overseas, will come under increasing pressure to expense executive stock options, but which will be first? Apart from doing what shareholders so obviously want, the Coca-Cola example shows there are plenty of brownie points up for grabs. Market Watch ALL eyes on Wall Street today after a torrid week for global equities ended with yet more volatility on Friday. Gold came to SA's rescue, just like old times. Business Editor Dave Marrs edited The Bottom Line. E-mail to bottomline@bdfm.co.za


				
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