WEIGHING THE OPTIONS
Tech Companies Fight Options Expensing
By CHRIS CZIBORR
Technology companies are fighting to stave off proposed accounting rules for expensing options, even as a deadline for implementation fast approaches.
Starting Jan. 1, public companies could be forced to account for stock options on their income statements, according to rules proposed by the Financial Accounting Standards Board.
Proponents of the rules, including investor groups, contend that expensing options would make for more consistent comparisons among companies that give stock options to their employees.
Options, which have value to employees, should be accounted for on a company’s income statement, they say. Supporters also argue that stock op-tions have given some corporate executives incentive to use accounting tricks to raise stock prices.
Expensing options has support in Congress, and many non-tech companies that give workers options already assign a value to them in their financial reports.
But tech companies, which long have used options in lieu of high wages to lure workers, have more at stake than companies in other sectors. They argue that stock option accounting would cause expenses to be overstated.
Net income results would be depressed under options expensing, with stock prices likely taking a hit as well, according to Palo Alto-based TechNet, a lobbying group made up primarily of chief executives such as Cisco Systems Inc.’s John Chambers.
Expensing “would not only be unmanageable,it would be inaccurate,” said Doug Farry, executive director of TechNet’s Southern California offices. The Southern California unit is based out of San Diego with offices also in Newport Beach.
Members of the region’s TechNet operation include Ted Smith, founder of Costa Mesa-based FileNet Corp.; Matt Massengill, chief executive of Lake Forest-based Western Digital Corp.; Dwight Decker, chairman of Red Hill, N.J.-based Conexant Systems Inc.; and Henry Samueli, chairman and chief technology officer of Irvine-based Broadcom Corp.
Elaine Levin, a partner in the Irvine office of Seattle law firm Preston, Gates & Ellis LLP, said the accounting change would disproportionately hurt companies with broad-based stock compensation plans. Such plans include all employees as opposed to just the top executives.
Small companies also could be hurt under the expensing regulations, Levin said.
“For startups,companies still in the R & D; stages that don’t have a large revenue stream,it’s going to affect them since they have to grant stock options to attract and retain the best talent,” Levin said. “At the same time, many smaller companies aren’t public, so they don’t have investors looking over their shoulders as much.”
Expensing, however, likely would reduce a startup’s profits. That could make it harder to attract venture funding.
“Expensing stock options will increase the time horizon for venture-backed companies’ reliance on expensive risk capital because it will take them longer to look profitable under these one-size-fits-all rules,” said Mark Heesen, president of the National Venture Capital Association, in a statement. “Many will struggle with the possibility of altering the incentive plans that have helped them grow in the name of preserving their income statement.”
Another issue: accuracy.
TechNet’s Farry said he doesn’t think companies can come up with an accurate way to expense options.
The accounting board has suggested two methods for expensing options, Black-Scholes or the Binomial Method. Both models have come under attack.
“Black-Scholes is based on short-term tradable stock option valuations and a number of subjective components that figure into it,” Levin said. “It doesn’t approximate what the expense is to the company because of lapses in stock options or other variables.”
In many cases, the expensing methods yield bloated valuations, said Mark Miskinis, an audit partner in the Costa Mesa office of Deloitte & Touche LLP.
“Most of the methods put forth to measure the value of options come up with a number that companies feel is too high,” Miskinis said. “These option models are based on a situation where you have public companies that could actually trade options on a market. Obviously that doesn’t exist.”
Argues TechNet’s Farry: “The accounting method the Financial Accounting Standards Board would be asking companies to use to expense the options assumes perfect know-ledge of how employees plan on using those options.”
But when options are granted, it’s impossible to know whether the employee will stay with the company long enough to exercise the option, critics say.
“The company won’t know in advance what the selling price will be when an employee chooses to exercise the option,” Farry said.
Tech companies still have lobbying to do if they want to kill the rules.
Some recent good news for their side: One effort to reduce the impact of options expensing was passed by the House of Representatives last week.
“The Stock Option Reform Act” would soften the financial accounting board’s proposals by limiting options expensing to the top five executives of a corporation. Small businesses would be exempt from expensing options under the act, and new public companies wouldn’t be forced to expense for three years.
Options expensing, however, has stronger support in the Senate.
A Senate committee has said in the past that it supports the Financial Accounting Standards Board’s plan to require expensing of all stock options.
It also said it doesn’t believe government should be legislating accounting standards, according to reports.
TechNet has been lobbying Congress to back the reform bill. The group earlier this year did a fly-in to Washington, D.C., to discuss the options expensing issue.
If the bill fails to become law, then the proposed stock option rules could be made effective as early as Jan. 1, though many believe the accounting board will push back implementation to 2006.
