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Stock Options Accounting Not as Problematic as Anticipated

July 25, 2006
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An accounting rule requiring companies to expense their stock option grants may not be as detrimental to firms as anticipated.

Last year, the Financial Accounting Standards Board mandated that all publicly traded companies treat stock options grants as expenses. Previously, companies could account for stock options in the footnotes of their financial statements.

The rule was met with much resistance, particularly from technology companies, which have relied heavily on stock options as a recruiting and retention tool. Their main argument was that it would make them less competitive and would slash their reported profits. Also, many companies claimed that it would add unnecessary costs to comply with the rule because firms would have to hire more accountants.

The first wave of companies, whose fiscal year begins January 1, began complying with the rule earlier this year, while the second round of firms are just now announcing earnings with options expensing.

Overall, analysts say that the effects of expensing stock options don’t appear to be as catastrophic as the companies had anticipated. The new accounting methodology may even provide some companies an excuse in explaining why their earnings are down, says Steven Hall, a partner at Steven Hall & Partners, a New York City-based executive compensation firm.

For example, on July 19 Intel and eBay both announced that their profits slid, and partially attributed the drop to stock options expensing. But only investment analysts and sophisticated investors who dig into companies financial statements can calculate the effect of stock options expensing on a company’s bottom line. Average investors won’t know the difference, experts say.

"The fact is that the real economics of the company hasn’t changed," Hall says. But this may mean that companies can use stock options expensing as an excuse for poor earnings, he says.

Companies should explain more about what they are doing to replace stock options and what all the expensing means when they announce their earnings, says Myrna Hellerman, a consultant for Sibson Consulting in Chicago.

"Savvier companies are explaining why they are or are not sticking with options," she says. "They aren’t just blaming low earnings on it."

The more long-term effects of the rule are yet to be seen, says Alan Johnson, a compensation specialist with Johnson & Associates. Particularly as companies change their incentive strategies to offer options only to top executives, they may find it harder to recruit employees at lower levels, he says.

"The fact that those lower-level people aren’t getting options anymore is the real shame," he says.

Jessica Marquez

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