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Bonus Boomerang in Taiwan?


When he was deciding whether to switch jobs two years ago, Chang-long Lee knew that Taiwan chip-design house Sunplus Technology Co. couldn't top his current salary. In fact, Sunplus was offering 15% less than what he earned as an electrical engineer for a government research institute. Sunplus offered Lee a perquisite that his old job couldn't match, however: an annual bonus of shares in the publicly traded company. So he made the jump to Sunplus, where he's now a manager. "It's like you are one of the investors in the company, so you work harder," says 38-year-old Lee, who is counting on selling his bonus shares one day to help pay school tuition for his two young children.

But Lee's annual windfall, and that of top employees at most Taiwan tech companies, is threatened. Under pressure from foreign investment banks and institutional investors, the government is considering changing the accounting rules so that companies must begin designating the share bonuses as an expense and charging them against earnings on their balance sheets. "It's a big issue for foreign investors in a bear market, when you are looking for reasons not to own stocks," says Robert Conlon, chief investment officer at Investec Asset Management Asia Ltd. in Hong Kong. Conlon says Investec has reduced its exposure to Taiwan tech stocks partly because of the accounting issue.

The proposal to change the accounting rules has Taiwan's high-flying tech industry girding for battle. The island's companies have never expensed stock bonuses, so changing the rules would wreak havoc on reported earnings for technology companies, which award most of the share bonuses (table). If the proposal were in force last year, some tech companies would have seen all their 2001 reported profits evaporate. The change would have knocked down United Microelectronics Corp.'s (UMC) profits by 86%, for example, while reported earnings at Sunplus would have plummeted 60%. No wonder some 100 representatives of tech companies convened in mid-November at Taiwan's Hsinchu science park for an urgent meeting. "Why should we make a change?" says Tai-shung Ho, chairman of Novatek Microelectronics Ltd. (NVTKQ) "The system has worked for over 10 years. You don't pay even one dollar to the employee, so I don't know how it could be counted as an expense."

That's not how foreign investors see it. Institutional investors have always hated companies handing out shares--or options that are later turned into shares--because it dilutes their own stake. One way to get companies to cut back on share issues is to make them pay for them. In the U.S., that means pressuring companies to assign a value to stock options as soon as they're handed out, instead of when they're exercised. Companies that don't fall in line are being punished via their stock prices. In Taiwan, it's the same. The Taiwan stock exchange tech index has fallen 27% this year, largely because of the global slump in the industry but also because foreign investors, who own 11% of Taiwan shares, are concerned about the share-bonus accounting. Stock-pickers who roam the globe looking for the best equities also hate to spend time puzzling over local accounting differences. Foreign investors "don't really feel comfortable" with Taiwan accounting, says Tony Tseng, a Merrill Lynch & Co. tech analyst in Taipei. "They want to get more apples-to-apples comparisons."

Foreigners certainly aren't getting those comparisons now. Instead of booking share bonuses as an operating expense that would reduce reported earnings, Taiwan financial statements treat them as a dividend, paid out of retained earnings--the earnings available to shareholders after the company pays its taxes and all operating expenses. That means companies can keep a big part of their employees' pay from affecting their reported profits. What's more, the bonus shares are recorded on the financial statements at par value, which is a small fraction of market value.

Here's how the share bonuses work at Novatek, which designs chips for liquid-crystal display monitors in Hsinchu, Taiwan's tech center. Last year, Novatek awarded an amount equal to 11% of its net profit as bonuses, paying employees $1 million in cash and handing out 6.7 million shares with a par value of $2 million. Those shares are worth $17 million at Novatek's current market price. However, other than perhaps the cost of printing up the share certificates, the company incurred no expense in awarding the stock bonuses, so under Taiwan's accounting principles, Novatek's net earnings didn't reflect any expense. If Novatek had to expense its bonuses at market value, its reported profits for 2002 would drop from an estimated $29 million to $11 million, and its price-earnings ratio would jump from 18 times earnings to a pricey 45 times earnings, says Merrill Lynch.

The share bonuses didn't cost Novatek any money, but they did add 2% to the number of shares outstanding--a number companies are not required to report--and in a weak market, that can be enough to depress the share price. In the U.S., companies often blunt the effect of dilution by buying back shares. But in Taiwan, buybacks were illegal until last year.

Of course, in the event the change is introduced and share bonuses are expensed, the hit to profits would be only on paper. That's because the companies incur no actual cost in issuing shares, and cash flow and actual earnings would not be affected. But the headline figures for p-e ratios and earnings per share would make the company's stock seem much pricier and would make some investors shy away.

If foreign investors get their way, the days of cost-free compensation soon may be over. The fear in Hsinchu is that companies will be forced to cut back on bonus shares and the island will lose its main competitive advantage: highly skilled workers. The ability to offer shares "has been a very important recruiting and retainment tool for us," says Harvey Chang, chief financial officer at chip giant Taiwan Semiconductor Manufacturing Co. (TSM) Taiwan execs argue that any change in the bonus policy may give an edge to rivals in China in attracting talent. Chang says he has talked to mainlanders who are looking to emulate Taiwan's generous bonus-share practice.

Some companies, including Novatek, are trying to mollify investors by paying bonuses in both shares and cash. But managers say that's not just expensive but also less effective in maintaining employee loyalty. "Employees will get cash rather than shares--and will go to start up other companies," says I.H. Yeh, president of Hsinchu chip designer ELAN Microelectronics Corp.

Policymakers face a dilemma in unknotting this problem. The government in Taipei is studying the issue, consulting analysts, accountants, and tech executives. Officials at the Economic Affairs Ministry and the Securities & Futures Commission are tight-lipped about what they might do. It's not even certain that legislation will be introduced. Saddled with low ratings in the opinion polls, President Chen Shui-bian may decide to put off the issue and avoid alienating the industry. Yet if Chen backs off, foreigners may hunt increasingly for tech stocks elsewhere.

There have been complaints about Taiwan accounting for years, TSMC's Chang notes. He predicts that once the bear market reverses course, worries about bonus shares will disappear. But until then, the pressure on Taiwan to get with the same accounting program as the U.S. may be too strong to resist. In that event, Sunplus Tech's Lee might just have to ask for a raise. By Bruce Einhorn in Hsinchu, Taiwan


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