Expensing Stock Options
Is FASB about to make a serious mistake?
A current debate being widely discussed is the possibility of the changing of the accounting treatment of stock options from a "no charge to earnings" to become an expense on the P&L statement. In recent days, hundreds of companies-including some of the US' biggest names such as Coca-Cola, American Express, and Ford Motor-have attempted to reinstate investor confidence by announcing plans to expense the cost of stock options. However, there are three main reasons to object to option expensing: the inability to properly value the options, the impact on the market, and the impact on non-executive employees.
L&A recognizes that there is value associated with employee stock options; however , current models attempting to assess this value fail to accurately determine the worth of an employee stock option. The difficulty with determining a reliable method to assess the value of stock options is simply: you can't predict the future (i.e. share prices, employees terminating, etc.) It is therefore useless to require or even to permit companies to expense stock options without consistency in the way they are valued. Not only is this unfair and difficult for investors to interpret, but also the inconsistency of the many valuation techniques will further create the temptation for manipulation of the inputs within these models. (see " Problems with Black-Scholes ")
Additionally, by looking ahead to the affects of option expensing, we see its impact on investors, the overall market, and non-executive employees. Investors and analysts will see more of a "haze" on earnings reports as they overlook the options expense to gain an accurate comparison of historical results. The market will see increased volatility as option expensing multiplies the movement of earnings per share, the price-to-earnings ratio, and therefore the stock price. Non-executive employees are pushed out of their broad-based stock option plans because it becomes too costly to grant options deep down into any organization.
In our opinion, a new methodology is needed to address this issue appropriately. To-date, laziness has affected this issue since no one has wanted to tackle the valuation of compensation options head-on. Rather, they want to settle for the use of other techniques used for non-compensation options that have true applicability here.
Overall, the idea of taking a charge to earnings for stock options is not one recommended by L&A at this time. Companies taking a stand against voluntary option expensing should be applauded, and those "volunteers" who are now expensing should seriously consider how they might have be essentially wasting their corporate assets. The "cost" of stock options is not one of a hit to earnings, but of dilution of ownership to the shareholders. To recognize it as any other based on a prediction of future stock price is not sensible, and will lead to serious consequences in the market.