New York (April 2, 2004) -- The long-standing controversy over the expensing of stock options reached a feverish pitch this week, as critics and supporters rallied following the unveiling of the Financial Accounting Standards Board's exposure draft, which would require public companies to expense the stock options and other forms of share-based payments they award employees.


Proponents say options should be treated like other forms of compensation -- as an expense -- and say doing so will give investors more transparent information. Currently, companies aren't required to expense options and only need to note them in the footnotes to their financial statements. But critics maintain that expensing options will lead to lower profits, stifle innovation, and make it harder for companies to recruit and retain employees. And they contend that the methods for valuing options aren't accurate.


The release of FASB's proposed rule coincided with the release of a study by Towers Perrin on the impact of option expensing on share price. The study of 335 companies that already expense options found that the decision to expense stock options has no impact on share price. The firm tracked the companies' share prices on the day of company declarations, and during the 150 trading days before and 150 trading days after, and found that share performance was the same, on average, as the 900 companies comprising S&P's 500 and mid-cap 400 indexes. The results were similar to findings of a study of 103 companies Towers Perrin conducted in 2002.


However, Rick White, chairman of the International Employee Stock Options Coalition, says the FASB proposal "will significantly distort companies' financial statements, making it impossible for investors to compare the financial picture of companies." As a result, White says companies will have "little choice but to severely curtail or eliminate broad-based employee stock option plans."


White contends that the Black-Scholes and binomial methods for valuing options "substantially overvalue" employee stock options, which he says differ "in numerous and significant ways from freely tradable stock options."


"Neither of these models work for what FASB wants to use them for," according to White, who says the Black-Scholes model "has been thoroughly discredited," while the binomial method "requires such a complex and dizzying array of assumptions and inputs that it will create an accounting free-for-all."


But Ed Nusbaum, chief executive of Chicago-based accounting giant Grant Thornton, disagrees. "There are many other areas in accounting that are subject to measurement uncertainty," said Nusbaum. "That uncertainty does not relieve a company of its obligation to make reasonable estimates." As examples, he noted that companies are required to determine the estimated useful life of equipment and recognize depreciation expense over that life, and to estimate the cost of remediating environmental contamination, as well as the costs of providing pension and post-retirement benefits to employees, settling product liability claims and settling litigation -- all of which are subject to measurement uncertainty.


"The objective of every business is to generate net cash from operations. The expensing of stock options will have no more impact on the ability of a business to generate cash flows than does the recognition of periodic depreciation expense," said Nusbaum. He refuted claims that expensing options will stifle innovation and make it harder to attract employees. While options enable companies to conserve cash that can be used in research and development activities, Nusbaum said, "We are not aware of any studies that support a direct correlation between the use of stock options and innovation. If there were a direct correlation, would the business landscape be littered with the failed 'dot-coms' that made liberal use of stock options?"


Lawmakers, who stonewalled a similar plan by FASB nearly a decade ago, are working on a bill to prevent the board from requiring companies to recognize the fair value of all stock-based compensation granted to employees in their financial statements. Nusbaum, along with others who favor expensing, have called on Congress to stay out of accounting standards-setting. "A standards-setter cannot be independent if it is continually looking over its shoulder to see if Congress is going to intervene on behalf of a particular constituency that did not get its wishes with respect to a particular standard," Nusbaum said.


However, William T. Archey, president and CEO of high-tech trade association AEA, says, "FASB's proposal drives a dagger into the heart of broad-based stock option plans and will force many companies to discontinue option programs and employee stock purchase plans for their rank-and-file employees."


"If Congress doesn't act, middle-class workers throughout our industry will be the victims of FASB's short-sighted efforts," said Archey.


-- Melissa Klein Aguilar

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