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Overriding the Financial Accounting Standards Board, and acting against the recommendations of the Big Four accounting firms, Alan Greenspan, and a host of good-business advocates like Warren Buffet, the House today voted against requiring firms to expense their options to employees.

That means, essentially, that the millions in lost revenues to companies that come with stock giveaways don't enter into the books of those companies. In short, employees are paid millions but it isn't recorded as a cost.

What's the big deal?

The big deal is that

(1) stock options are generally a means to provide hugely inflated incomes to top executives in a way that is more likely to escape the public eye or be seen as justified. People reason that if the stock went up that much, the executive must have earned the extra income, without fully considering the highly discounted price at which those options were given out (sometimes pennies on the dollar). This, naturally, contributes further to widening the wealth divide in America.

(2) Companies don't expense their options because once they're counted as costs of doing business, the profligate use of these tools comes under greater scrutiny. Companies are afraid that they won't be able to give them away so freely. They argue that these rewards to employees stimulate growth. To some extent, this is true. People like to be rewarded. At the same time, there is no evidence (that I'm aware of) that very high levels of employee options actually improve the performance of a company. This is especially true for top executives. In fact, studies have been done which indicate that there is no correlation between the level of pay for top executives and company performance. It has much more to do with the size of the company, the relation of the CEO to the board, and the corporate culture.

(3) Giving out options dilutes the shares in a company and hurts investors. It also is a loss of potential revenues for a company, and in that sense hurts growth. These both must be weighed against any increase in employee productivity relative to salary. I have never seen or heard of any study which backs up the economic claims of House members who overrode the Accounting Standards board.

(4) The reform in stock option expensing was done to bring a greater accountability and sobriety to corporations, and to increase the trust of the public that the books accurately reflect the company's operations. This move by the House undermines these objectives.

(5) Finally, one objection to expensing is that it is complicated and will make accounting more difficult. That is true. There is also an element of stipulation in the formulas setting the value of these options. But the formulas are not arbitrary, and in any case the House bill to override the Accounting Standards board cannot appeal to this argument because they kept the rule that the options must be expensed for the top 5 executives. This does reduce my first concern, but it makes the Bill an excercize in hypocricy. If the expensing standards are arbitrary or too difficult, the thing to do is eliminate them entirely.

You can find the full Yahoo story here.

Originally posted to jd in nyc on Tue Jul 20, 2004 at 01:54 PM PDT.

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