Stock options and Congress

There is a huge argument on Wall Street and Capital hill right about what’s the proper way to account for stock options, and the whole thing is muddied further by the fact that neither side understands the whole thing. The Republicans actually have a very nice argument, but none of them can seem to articulate it.

On one side of the fence you have Greenspan and, surprisingly, the democrats. Greenspan has said that all the serious analysts have already factored in the dilution of stock options into their analysis, so releasing the data publicly should have no real effect on the markets. This is a very potent argument because if it’s not going to make a difference, what do you have to hide? Basically this falls in line with Greenspan�s drift towards transparency. The democrats are suggesting that stock options be shown in the bottom line. Republicans argue that it’s hard to accurately value stock options, but the dems are quick to counter that if it’s not worth anything, employees wouldn’t accept it as a form of compensation and if it is worth something than it should be reflected in the company’s books when they give it out. Wall Street, whose opinions are influenced more from the frenzy following Enron than anything else, also follows this line.

On the other side of the aisle, there is incredulity that people are suggesting that the books are tainted with something that cannot, as things stand, be accurately valued. There is a duality in options in that they are both income and remuneration. What it all really comes down to though is that options don’t cost the company money. The FASB almost mandated subtracting options from the bottom line but after an uproar from Silicon Valley and the Senate banking committee (most notable Phil Gramm) the proposal was reduced to a footnote, and with good reason. If my company has 5 million in profits from selling widgets, and I’ve given employees a million dollars worth of options, the company has still made 5 million dollars from widgets, there’s no reason that I should subtract a million dollars from my reported profits when it doesn’t accurately reflect my business.
There are a number of ways to account for options out there, most notable the Black-Schoals model that the most common, however not because it is good, but it’s simply the best out there. There are also guidelines for reporting options in taxes, and many have suggested that these should simply be applied to accounting. There are several problems with this, but the most serious is that tax laws are written to encourage and discourage businesses from doing certain things, and by definition accounting should be neutral, so if these suggested methods are introduced as accounting standards then suddenly there are very persuasive elements in the books that are going to change the way companies do business, and not necessarily for the better. Also, the minute that congress starts telling accountants what to do; accounting will become the only federally regulated profession out there. Doctors, lawyers, brokers, all exercise the right of self-regulation. You don’t see anyone suggesting that congress go create mandates for lawyers after Enron, even though arguably their law firm (whose name escapes me at the moment) is just as responsible for the situation as their creative accountants.

While I’m on this tangent I would like to suggest that the long term solution to the problems in the accounting business is to introduce competition into the field. Among large corporations there is a monopoly among the “Big Four” that now dominate the field, and there is really no incentive for them to rock the boat too much. If meaningful competition exists for the big accounts, such as GE and Fannie Mae, I think we’ll start to see the market forces drive accounting like they drive nearly every other profession.

Anyway, reporting stock options in the manner that the democrats and the more liberal media are suggesting will ultimately stifle the way business is done and hinder productivity, and therefore growth, in the long-term. Options give firms the oppurtunity to attract talent to the company that they could otherwise not afford, and give the employees’s of a stake in the company and interest in seeing that the company does well. A conversation earlier today Wayne Abernathi really clarified many of the things I’d been reading on the subject, and offered many of the insights here. He’s a really great staffer on the Senate Banking committee who deserves more recognition. He was one of the driving forces behind the Gramm-Leach-Bliley bill that revolutionize, amoung other things, banking regulation

3 thoughts on “Stock options and Congress

  1. I wasn’t put to sleep, although I must admit this was over my head! The main thing I’m unclear on is (besides, well, everything) what exactly is the Republican stance on accounting for stock options… just that it can’t be done, since they don’t affect net profits or losses?

  2. I would say that’s partially correct, that because stock options have different functions and don’t actually cost the company money they shouldn’t take away from real profits.

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    Stephen B.,
    A Halifax Chartered Accountant