FASB announces options expensing rule

Renewing one of the most politically controversial battles in financial history, accounting rule-makers in the US have announced a formal proposal that would force Silicon Valley companies to deduct billions of dollars from corporate profits to account for the cost of stock options.

Now the clock is ticking: The technology industry and other opponents have only three months to recommend changes to the rule — and less than nine months to persuade Congress to block the rule before it takes effect in mid-December.

The Financial Accounting Standards Board change — which accounting rule-makers have favored for more than 30 years — would hit the Silicon technology industry harder than other sectors because it doles out more stock options. At the peak of the tech boom, a Gallup survey indicated that one in three households in Santa Clara County held options.

If companies had been required to “expense'' stock options in 2003, Cisco Systems' earnings would have plunged nearly $1.3 billion. The toll at Intel, Hewlett-Packard and Oracle would have been $991 million, $733 million and $330 million, respectively. And Sun Microsystems' losses would have been $519 million deeper.

Many companies warn that taking such a bottom-line hit would force them to slow the flow of options, compounding the cutbacks in the wake of mounting shareholder pressure to rein in option use.

Even though options are an integral part of the culture at Sun Microsystems, for example, mid-level manager John Jennings fears that founder and chief executive Scott McNealy would have no choice but to share fewer options with rank-and-file workers.

“If Sun has to take a huge hit to the bottom line, this won't play out,'' said Jennings, adding that options have comprised a “significant'' part of his pay in his 10 years at Sun. “Shareholders will not let Scott do that.''

This is not the first time accounting rule-makers have tried to expense options. That goal has been around since 1972, but accounting rule-makers shelved the idea because they couldn't find a way to put a price tag on options then. The debate renewed in 1993, however, when the Financial Accounting Standards Board proposed a rule to do just that.

With the powerful technology industry spearheading a revolt, Congress threatened to choke off the accounting board's independence if the rule went through. In 1995, the board backed down. Rather than forcing companies to deduct the cost of options from profits, it allowed them to disclose the cost only in the footnotes.

The arguments against reporting stock options as an expense haven't changed much in the past decade. Namely, critics say option values are overstated, making it more confusing for investors to compare companies.

But unlike a decade ago, the technology industry's chances of winning a reprieve on Capitol Hill is far from certain. Here's how the political landscape has changed:

• Many Americans are outraged. Critics say stock options contributed to inflated stock prices that eventually crashed, costing investors billions of dollars and tempting executives at Enron, Worldcom and other failed companies to manipulate earnings so they could cash in options. Although rule-makers say their intent is simply to improve accounting standards, corporate scandals shook the public's faith in the stock markets, giving rule-makers political cover they didn't have a decade ago.

• Lawmakers aren't rallying to the cause. In 1995, the accounting board backed down to political threats from Sen. Joseph Lieberman, D-Conn, and the GOP-controlled Congress to choke off the board's funding and independence. But in 2002, the Sarbanes-Oxley Act's reforms bolstered the board's independence.

For the past year, the technology industry has been struggling to find allies on Capitol Hill, and legislation to thwart the accounting board's proposal has languished. The bill with the widest support would scale back the option proposal to require companies to “expense'' only those options given to their top five highest-paid executives. That bill has not progressed since a subcommittee hearing early in March.

• Shareholders are demanding it. Major corporate investors were ambivalent about whether companies reported their stock options as an expense during the 1990s. Not this time. Labor unions, investing their pension funds in corporations, have mounted coordinated campaigns to pressure scores of companies to rein in executive pay and to start expensing options. In Silicon Valley, shareholders have approved non-binding expensing recommendations at Hewlett-Packard, Apple and PeopleSoft.

• International accounting rule-makers are doing it, too. Moving in tandem with U.S. rule-makers, the International Accounting Standards Board ruled last month that 7,000 companies in 90 countries must start subtracting options from profits in 1995. This would eliminate the argument that European companies would have a competitive advantage over U.S. companies.

• Hundreds of companies already are doing it. About 500 companies already have started expensing or announced they will do so, including Coca-Cola, General Electric and nearly one-fourth of the companies in the S&P 500.

The tech industry counters that these companies have relatively little to lose because they're more miserly with options. But Microsoft broke from the tech industry's united front last July when it stopped issuing options and volunteered to count all stock-based employee pay, including previously granted stock options.

Although they continue to fight expensing, many companies in Silicon Valley already are slowing the flow of options to their employees and substituting other forms of pay trigger accounting charges even under current rules.

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