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Congress threatening to derail stock options reform again

Posted: Friday, June 11, 2004

NEW YORK (AP) A stock option is a stock option, whether it's granted to the CEO or a mail room clerk.

It's a seemingly inescapable bit of logic that nevertheless seems to have escaped the backers of a proposed law gaining momentum in Congress which would govern when and how to treat options as an expense.

The bill, which a House committee seems likely to approve this month, would require companies to record an expense on their profit reports for only those stock options given to the chief executive and the next four highest-paid officers. Options issued to all other employees would not be deemed an expense.

To be holding this debate in a legislative setting at all is to conjure up unhappy memories of the last time, about a decade ago, that members of Congress succeeded in pressuring the rules makers for the accounting industry to back off on a bid to require options expensing.

That ''success'' helped lay the speculative foundation for the technology boom and bust. The ensuing proliferation of stock options as a form of compensation without cost conspired to corrupt the incentives of executives and distort financial reports meant to inform the investing public.

Between 1995 and 2003, nearly $215 billion of options expense was not subtracted from the combined profits reported by the companies in the Standard & Poor's 500-stock index, according to an estimate by The Analyst's Accounting Observer.

The only true logic behind the proposed legislation would seem to be that something is better than nothing that reflecting the expense of options given to the top five executives is better than the current system where companies record no expense at all.

But implicit in the bill's decision to start expensing for the top five executives is a clear acknowledgment that there is an economic cost to all stock options issued to employees, no matter what rank.

It's only in the spirit of compromise that the bill's authors conceived of this double-standard. And while compromise is a necessary art in the world of legislative politics, it's a bad idea to adopt inconsistency as a core accounting principle.

''Either your position is that they're not an expense to the firm and they should not be subtracted, or they are an expense. But to cherry pick who to expense?'' said Mary Ellen Carter, an accounting professor with The Wharton School at the University of Pennsylvania.

The original intent behind the current bill may have been to exert new pressure on the Financial Accounting Standards Board.

But the FASB withstood the pressure this time, issuing a proposal in late March that would require all publicly traded companies to record all options granted to any employee as an expense.

So now, having failed in their pressure play, the politicians are stuck with their bill, threatening to bypass the FASB entirely and designate themselves as skilled arbiters of accounting principle a questionable assertion, judging from their first rendition of Solomon-like accounting wisdom.

With 115 official backers, about half the number needed to pass in the House, the bill still faces hurdles, including uncertain support in the Senate. But the measure gained new momentum last week when Michael Oxley, the Republican chair of the House Committee on Financial Services, signaled his support by introducing his own version.

The renewed push has been prodded by a technology industry which remains largely adamant that options expensing would smother innovation and entrepreneurial investment. That argument ignores the decades of innovation and entrepreneurship that preceded the options boom of the 1990's, as well as hundreds of failed technology startups whose flimsy business models might have been more suspect if they presented the real compensation cost represented by options.

Nevertheless, the bill also would excuse newly public companies from deducting any options expense for three years, as well as smaller companies with revenues and market value of less than $25 million. Bizarrely, though the purpose of these two exemptions is to ensure a continued source of cheap fuel for smaller businesses to grow, the bill would also grant a free three-year pass to Google, an established Internet juggernaut which plans to sell billions worth of stock in an initial public offering.

The bill's backers also try to draw precedent for their approach from the current disclosure rules for executive pay, which require companies to report the total compensation for the CEO and the next four highest-paid officers.

But disclosure of how much a company's top decision-makers are paid is a very different issue from how a business accounts for the cost of stock options in its books.

Congress took the wrong turn on the issue of options a decade ago. It's hard to imagine, after all the financial tumult of the past few years, it would risk doing it again.

Bruce Meyerson can be contacted at bmeyerson(at)ap.org



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