June 30, 2004

THE DANGER OF LISTENING TO PAUL KRUGMAN:

Kerry Flip-Flops... Again (James K. Glassman, 06/30/2004, Tech Central Station)

The House of Representatives is ready to pass a bill that would sharply limit an attempt by an unelected accounting board in Norwalk, Conn., to force U.S. companies to guess the costs of broad-based employee stock options and write them off as expenses when they are issued.

If the Financial Accounting Standards Board gets its way and stock options are expensed, it's almost certain that many businesses, including high-tech firms, will stop issuing them, and American innovation and competitiveness will suffer.

It all comes down to the Senate, where the House bill is being blocked by a few key legislators. Among them, according to an article in Monday's edition of National Journal's Technology Daily, is John Kerry, who, a month from now, will become the Democratic nominee for president.

In a speech in Silicon Valley last Thursday, Kerry extolled the benefits of stock ownership but, in the words of his economic policy director, Jason Furman, the Senator "believes that companies should be required to expense stock options."

As Drew Clark wrote in Technology Daily: "Some believe that Kerry's lack of support for an issue that TechNet CEO Rick White calls the 'number one, two and three issue' current of interest to technology companies could cost him support within the sector." By contrast, said White, "The president is clear that he is against expensing stock options."

Kerry is, at least for now, clearly in favor of expensing. But he did not always take that position.


Hating corporations is so pre-9/11.

Posted by Orrin Judd at June 30, 2004 5:01 PM
Comments

The proposed new rule is stupid, but it is probably harmless. I suspect that harmlessness is its most attractive feature, as FASB thought needed something to throw to the wolves after Enron, et al., and figured this was pretty safe.

Posted by: David Cohen at June 30, 2004 5:06 PM

"an attempt by an unelected accounting board"

Now if it was an unelected judiciary, there'd be no problem...

Posted by: Raoul Ortega at June 30, 2004 5:31 PM

Well, corporations should have to treat stock options as an expense. They are used overwhelmingly as a payroll supplement.

True, technologies companies tend to "pass them out to the boys in lieu of pay."

Posted by: Brandon at June 30, 2004 5:39 PM

And why shouldn't they be a payroll supplement?

Posted by: Timothy at June 30, 2004 6:30 PM

I'm not saying that they shouldn't, but when they are used like any other payroll expense they should be treated as such.

Posted by: Brandon at June 30, 2004 7:12 PM

I heard this great joke about kerry. He has an economic plan, unfortunately there aren't any rich women for the United States to marry.

Posted by: pchuck at June 30, 2004 9:01 PM

Well, of course the FASB is unelected, it's a professional standards board! Why don't we elect auditors while we're at it?

The rule makes sense, it offers stockholders and other interested parties a way to accurately assess the profitability of a company by getting a truer picture of it's cost of doing business.

Posted by: Robert Duquette at July 1, 2004 1:15 AM

Robert: The rule is stupid, but it is stupid in a fascinating way. Actually, in two fascinating ways, one of which is makes sense to accountants but not to economists, and the other making sense to economists but not to accountants.

From an economic point of view, it is nuts to think that the market distinguishes between the following two statements: X Corp. reported earnings of 18 cents per share in the second quarter (15 cents per fully diluted share; and X Corp. reported earnings of 15 cents per fully diluted share in the second quarter (18 cents per currently outstanding share. If that actually made a difference to share price, then, among many other things, you can throw out the fraud on the market theory and never have a securities fraud class action again. (Hmmm . . .)

Accountants are fine with the second wording because it is precise, but caring about the difference makes no sense from an economics viewpoint.

The second problem is going to be valuing the options at the time of grant, which is going to be entirely fictitious. Black Scholes simply has no application to what is a very specialized piece of paper without a market and dependent on very particular circumstances. Between deciding when to grant the options and how to value them, what we're really doing is giving management a tool to shape earnings such as to make derivatives a child's plaything. Accountants are going to throw up their hands and simply defer to management, since the whole thing is such handwaving. If, ala Warren Buffett, management throws the whole valuation over to First Boston or some other investment bank, it is still going to be handwaving, and we know how well investment banks stand up to their customers.

If we really want to do this, what we need to do is have a reserve taken at grant that is drawn upon at exercise.

Having said all that, if there were actually any value in doing any of this, the market would reward companies for doing it, shareholders could factor option grant accounting in along with everything else they look at, and still no regulation would be necessary.

(I apologize that this is a little telegraphic. I'm rushing to get this out before I leave the house.)

Posted by: David Cohen at July 1, 2004 7:54 AM
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