It matters who's right on this one, because the stakes are high. Bear Stearns estimates that the earnings per share of the companies on the Standard & Poor's 500-stock index would have been 9% lower in 2000 if they had been forced to record stock options as a compensation expense. For some companies, the hit would be far worse.
BusinessWeek reported recently that expensing options would have lowered 1996-2000 earnings by 66% at Viacom, 30% at Lucent Technologies, 28% at Pharmacia, and 26% at Cisco Systems (see BW, 3/4/02, "Too Much of a Good Incentive?").
ON BUFFETT'S SIDE. Granting stock options as compensation also creates significant corporate tax breaks -- $2 billion worth in 2000 for Microsoft alone. When a worker exercises an option, the company can deduct the difference between the price he or she pays and the stock's market value. On Capitol Hill, Senator Carl Levin, a Michigan Democrat, and Senator John McCain, the maverick Arizona Republican, are trying to shut that door.
Greenspan is on the side of superinvestor Warren Buffett and most economists and accountants, who believe stock options should be reported as compensation. In a Mar. 26 speech at New York University, Greenspan argued that they should be treated just like salaries and cash bonuses.
Such a requirement would lower profits at many companies and possibly scare away some investors who hadn't previously understood how expensive options can be. But that doesn't bother Greenspan, who told the NYU crowd: "If investors are dissuaded by lower reported earnings as a result of expensing, it means only that they were less informed than they should have been. Capital employed on the basis of misinformation is likely to be capital misused."
"VERY SMART." Then came Bush, holder of a master's degree in business administration from Harvard Business School. In an interview with the Wall Street Journal published on Apr. 9, the President said, "Alan Greenspan is very smart. I'd hate to get into a debate with him on it." Still, Bush expressed a view common to many of the MBAs who run companies that issue lots of employee stock options: He opposes counting stock options as an expense that shows up on the bottom line.
Instead, he favors keeping matters pretty much as they are. The President believes options that are in the money should figure into a company's calculation of its fully diluted earnings per share, which is current practice. "In the money" options, by the way, are those that are worth exercising because they entitle their holders to buy shares at below the current market price.
Who makes a better case? Bush's argument sounds reasonable enough. After all, the way big stock-option grants hurt shareholders is by diluting their ownership of the company, forcing the company's profits to be spread out over a larger number of shares. So as long as the potential dilution is recognized in the statement of fully diluted earnings per share, Bush argues, what's the problem?
Well, here it is: Adjusting the earnings per share figure alone doesn't give a complete financial picture. Imagine that a company sold a bunch of shares to the general public, instead of giving them away to its own employees, and then used the proceeds from the sale of shares to raise employees' salaries. No one would question that the higher salaries should be counted as a business expense that lowers profits, and earnings per share would simultaneously fall. Giving the shares directly to the employees has the identical effect and so should have the identical accounting treatment. Shouldn't it?
SPELL IT OUT. With Bush and nearly every major corporation lining up to fight the expensing of options, it's unlikely that major changes will come anytime soon. Even the Levin-McCain bill faces an uphill struggle.
When you think about it, though, it's a little strange that businesses are so ferocious in their opposition to accounting for stock options as compensation. If it's true, as they and the President say, that investors already understand how stock-option grants affect their shares, then why would they care about spelling it out in the income statement?
It's a simple matter of transparency. If we've learned anything from the Enron debacle, it's that there's no harm, and a lot of good, in making things perfectly clear to the investing public. Coy is BusinessWeek's Economics editor