A stand on Stock Options
In times of tremendous economic growth, not many seem to mind if a few irregularities exist within a business or its financial reports. As long as stock prices continue to rise and everyone continues to accumulate wealth at astonishing rates, players in the financial markets are happy to avert their eyes from the (often) egregious abuses, excesses, and violations that have occurred on a regular basis for as long as anyone can remember. This fact (like it or not) applies to you, and it applies to me. In the last several years, we have seen once again that circumstances like these are not capable of perpetual existence. In the long run, not everybody wins, and the losers come up screaming for blood. Such has been the case in the wave of corporate scandals that have come to light. While shareholders and employees of large corporations saw their money and their jobs disappear, greedy corporate executives continued to manipulate stock prices for their own benefit, often taking in hundreds of millions of dollars from large stock option exercises. Historically, stock options have been viewed as a linkage between individual/company performance and shareholder value. Somewhere along the line, the linkage diminished if not disappeared. Testifying before Congress in 2000, former Enron executive Jeffrey Skilling admitted, � Essentially, what you do is issue stock options to reduce compensation expense and therefore increase your profitability� (Stock Options Come Under Fire in the Wake of Enron�s Collapse). During the 1990�s, the percentage of executive compensation accounted for by stock options increased to previously unseen proportions. Executives were thus compensated based upon short-term stock price performance, over which they exerted tremendous control. To summarize what eventually came about, we can use the reaction of former Healthsouth CEO Richard Scrushy when accounting personnel told him he should abandon earnings manipulation tactics. His reaction: � Not until I sell my stock.� So, what exactly happened? As we have seen, stock options provided a means for corporations to reduce their compensation expense. Unlike cash compensation, companies are not required to record stock options on the income statement (they can still be found in the footnotes). Not only are corporations not required to account for options as an expense, they are also able to deduct the cost of options from corporate taxes. Cisco has gotten tax breaks that sometimes exceeded reported net income, Microsoft got a $2 billion tax break as a result of exercised options, and some well-known tech companies reported net incomes that would have been negative if exercised options had been expensed. Additionally, options � repricings� have further distanced the interests of executives from their shareholders, allowing continued profit at a reduced strike price even in times of declining stock price. The Sarbanes-Oxley Act of 2002 has sought to prevent many of the circumstances that lead to the collapse of corporate giants. It seems odd, then, that the act did not contain any provision requiring the mandatory expensing of stock options (it does, however, preclude executives from borrowing money to exercise options). Reasons for the
omission include the difficulty of appropriate options valuation (since these stock options do not trade in open markets, can we apply the Black Scholes model?), the manner in which a company acquires the stock at the time of exercise can vary, options may eventually expire worthless (requiring a myriad of adjusting entries), and some powerful influences still insist that stock options are valuable tools. Nevertheless, in today�s times of increased corporate governance, calls for greater financial transparency of public companies, and widespread desire to avoid a recurrence of the recent past, the consensus has shifted towards mandating the expense of stock options.