by Paul B.W. Miller and Paul R. Bahnson

Summer vacation is here. The time that we would typically spend putting together our column is committed to traveling around the beautiful West with our families. Instead of missing an issue, we decided to revise and remix one of our prior columns from a couple of years ago that made some points that are equally valid today.

We originally wrote it to comment on the response of some politicians in Washington to the Financial Accounting Standards Board’s decision to do away with poolings of interests, and the Securities and Exchange Commission’s proposal to tighten the definition of independence. We have inserted changes (the italicized text) to substitute stock options, the never-ending hot-button issue, and to add a new track that reports the names of the new players in the “let’s get together and save the capital markets from FASB” game.

Despite the passage of two-and-a-half years and the substituted accounting issue, you will see how the original column provided a nearly perfect template for this one. We’re reminded of the old adage that the more things change, the more they stay the same.

One coin, one song

In a time of downloadable music and portable players of all kinds, it’s hard to believe that you used to have to go to some length to hear the music you were craving. In fact, the state of the art used to be jukeboxes that could be found most anywhere from bars to malt shops. They all worked the same way - you put in money, you pushed a button, and out came the chosen song by the chosen singer. Of course, you only got one song for each coin. That was it - just the song you paid for and nothing else.

What does this have to do with accounting today? Well, we see a similarity to what has been going on concerning stock options.

After years of study (and after decades of controversy, dating back the Accounting Principles Board in the 1970s), FASB is ready to finally bury the long-standing practice of not reporting an expense for stock options granted to employees. The due process has been thorough and careful, and the board members know that their decisions will be scrutinized and opposed.

Nonetheless, they have responded with conviction to their mandate to increase the transparency of financial statements by sticking with their plans to end this undeniably incomplete and misleading practice.

But let’s get back to the jukebox idea. Here’s what we think has happened in this and other controversies: Some accountants (including those who might be called leaders in other circumstances) who oppose these changes have gone to Washington with large bags of coins. They have then gone up and down the halls of the Senate and the House office buildings, putting money in slots and pushing buttons to hear the music they want to hear.

Just like in the old days, they have gotten what they have paid for - the words and the music are sung by the performers they have chosen. In this case, the tune is heard in the letters signed by members of Congress (who also might be called leaders in other circumstances), threatening to intervene with legislation and who knows what else to circumvent the proposed reforms.

For example, Sens. Michael Enzi and Barbara Boxer of California shamelessly took the lead in sending a letter to FASB demanding that it reconsider its position on options. This one must have taken a lot of coins because it was signed by 13 other senators. We won’t believe that this outpouring of concern was spontaneous, with no impetus from managers and their accountants.

Another example was legislation introduced by Reps. David Dreier, Anna Eshoo and others that would force FASB to defer implementing its standard. It is surely no coincidence that they’re both from California, where options are more common than hot tubs.

Of course, there is nothing wrong with open expressions of opinions that are contrary to proposed changes. However, these artificially induced expressions are ludicrous and ineffective. It’s possible that we’ll never know, but isn’t it unlikely that this many people in Congress would ever care on their own what FASB does? For that matter, could any of them even tell you what FASB is supposed to accomplish?

There is a bigger problem, too, in the sense that these actions are totally misconceived. The underlying premise is that putting an expense on the income statement will damage the high-tech industry by making it harder to grant options. This argument is fallacious for two reasons.

In particular, the singers miss a huge point. Presumably, they want options kept off the books in order to keep the companies’ cost of capital lower than it would be if the markets were more fully informed.

What they’re missing is that this strategy aims to trick the stockholders, including ordinary citizens, as well as pension funds and mutual funds, into accepting a rate of return that is inappropriately low for the risk that they’re facing. As such, they would be the victims of the managers’ deception. The public officials in Congress are actually joining a conspiracy to defraud part of their constituency. Somehow, this aspect of the issue was never mentioned in the hearings on options.

However, the absurdity does not stop there. To rationalize their demand that options stay off the books, the jukeboxes and the coin flingers have to assume that capital markets are indifferent to the difference between incomplete and more complete financial reports. They also have to assume that the markets are well served by superficial messages in generally accepted accounting principles financial statements, instead of the underlying substantive truth.

However, to markets as efficient as ours, the odor of a bad deal quickly seeps out. In fact, income statements that don’t include options expense actually signal management’s untrustworthy intent to hide facts. Because the capital markets are left guessing about the options overhang, and because they know that they’re guessing as a result of management’s deliberate goal of deceiving them by not telling the whole truth, capital costs are higher than they would be if the statements simply revealed more truth.

Oh yeah, one more thing. Once an old jukebox finished playing a song, that was it; there was no more action unless another coin was inserted. That’s how it works in Congress, too. What are the chances that legislation will ultimately be introduced on an issue that leads to incomplete financial reporting? Who in Congress is going to waste political capital on controversies that mean little to the media and the voters back home, especially during the last year of a new administration? They have more and bigger tunes to sing.

Thus, we say to FASB - your opponents’ bags don’t contain enough coins to create anything other than a bit of temporary noise. So, just go ahead and do the right thing, and don’t worry about Congress. We think that will be music to the capital markets’ ears.

Second verse, same as first

The neat thing about a remix is that it sounds a lot like the old version with just a few minor changes to introduce an element of surprise. Unfortunately, it is no surprise that these and other members of Congress are willing to sell their integrity for a few contributions to their re-election funds.

This remix sounds more like the same song, second verse. When will these people ever learn that the best thing for the capital markets is the truth, the whole truth and nothing but? It doesn’t look like it’s going to happen anytime soon.

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