Everyone in Silicon valley has an opinion
on whether Stock Options should be expensed. Usually this is purely a function of whether you have options which are "in the money" or not. My own feeling is that they should not but I try to make this determination independent of any finanacial impact it might have. Instead (and this is novel), I try to use logical arguments - lamentably, logic is not the coin of the realm when you are talking about accounting rules. Essentially the thesis is that stock options are issued to employees (some to executives, some to employees, some to others / V.C.s) but are not accounted for as an expense. The theory then is that companies should account for the stock when it is issued
- the problem is, you don't know what the options will be worth when / if they are exercised. For example, the person getting the options could quit before they vest or the options could be "under water" and never be exercised. To solve this conundrum, we blindly use the Black-Scholes equation which is used to price options. Whether it actually works for stock options which have more constraints on them is debatable but basically, it's the best thing we have... In theory this is all just a paper tiger since the options don't actually cost the companies any cash. Rather the issuing of new shares to grant options dilutes the value of current shares - it's like your a country and you just keep printing money.
Here is why I think expensing is a bad idea:
- I fear what will happen (and to a large extent has happened) is that stock options will be considered to "expensive" and companies will have to find other methods of compensation (like Microsoft switching to allocation shares or cash) which will impact the bottom line because these things cost real money (a.k.a. cash).
- The reality is that in the long term, most options are accounted for when the company does a stock buy back (which costs real cash). Granted some companies just keep issuing new shares but that effects the earnings per share anyway.
- The black-scholes model that everyone is so high on using to guestimate the future value of the option seems arbitrary - I don't know why (if options must be expensed) they don't expense the options when they are excised.
The motivation for expensing options is primarily driven by peoples "outrage" over the fatcats at Worldcom / Enron who issued themselves millions and millions of options and then cooked the books to key the stock price high so they could sell out. The problem with expensing all options is that those same executives will continue to grant themselves options, at the expense of the employee stock options. Things like this are to the long term detrement of the company, but as we know, nobody cares about the long term