The good old days of providing misleading information on your financial statements are probably over. Today the Financial Accounting Standards Board (FASB) published its new rule that will provide investors and other users of financial statements with more complete and neutral financial information by requiring that the compensation cost relating to share-based payment transactions be recognized in financial statements (this is simply a very complicated way of saying that options need to be expensed, but the FASB is referring to other similar compensation arrangements including restricted share plans, performance-based awards, share appreciation rights, and employee share purchase plans). That cost will be measured based on the fair value of the equity or liability instruments issued. This Statement is the result of a two-year effort to respond to requests from investors and many others that the FASB improve the accounting for share-based payment arrangements with employees.
The technology (and now-dead dot-com stars) were the most vocal proponents of stock options. Many arguments were presented including their capability to attract the best and brightest. Now that the tech sector is no longer hot and high unemployment rate has made very bright people willing to work for half of what they used to make, it is a good time to start expensing options.
Currently, approximately 750 public companies in the U.S. are voluntarily using fair-value-based method of accounting for share-based payments or have announced plans to do so. This methodology is also supported by people like Grove, Greenspan and Buffet. I am sincerely hoping that this rule does not get bogged down in Congress.
Why am I in support of expensing options?
- It makes apples-to-apples comparison possible for financial information of different companies.
- One can get a more realistic picture of the financial health of a company when options are expensed.
- It will reduce (if not eliminate altogether) the obsession with stock price. While no one will argue the price of the stock as an excellent measure of value created but when executives can hope to get rich if the stock price touches some magic number then there is a strong incentive to manipulate numbers.
While expensing options is a better option, I am not sure that it will make the financial statements as transparent as we would like them to be. Since some numbers will still need to be estimated, one may never fully appreciate what the future liability of a company may be but expensing options is a good step in the right direction. And I am confident that companies will figure out a way to compensate the best and the brightest. There are a million ways to motivate employees.
Recommended article in Strategy Blog: Send your employees on a spa vacation