The Cold, Hard Numbers on Stock Options

Call it a bubble within a bubble. The extraordinary enrichment of company management, at shareholders' expense, is a bubble within the bubble of the 1990s' stock market. The market's bubble has already burst, led by the Nasdaq, and the options bubble may soon follow suit.

What will precipitate the collapse of the options bubble? First and foremost, it's a matter of getting the facts out. "Facts are stubborn things," as John Adams once said. I've called options a "scourge" and a "dirty little secret" in prior RealMoney columns. But this story doesn't really require inflammatory language. Everything we need to know is in the facts -- the cold, hard numbers.

I've reviewed the 10-Ks for the top 15 companies in the Nasdaq 100. Three of the top 15 are not included in my analysis below: Comcast (CMCSA - commentary - Cramer's Take) and Nextel (NXTL - commentary - Cramer's Take), which have valuation allowances against options because they didn't have income, and Ericsson (ERICY - commentary - Cramer's Take), which is a foreign company. The market value of the 12 remaining companies that I've reviewed represent 62% of the Nasdaq 100, a market-weighted index.

In the table below, I've taken the last five years of reported income and subtracted the cost of options to reveal the "true income" of each company. As you can see, more than 56% of the income ($61 billion divided by $108 billion) generated by these companies over the past five years has been allocated to benefit management, not shareholders. The "true income" is the amount of reported income left over for shareholders, after the management grab.

How did I arrive at "Option Cost" in that table? This calculation is based on the tax benefit, disclosed in 10-Ks, that each of these companies gets from deducting options expense on their tax returns. Options are fully deductible as compensation expense. Companies even withhold payroll taxes on options. (So much for the argument that they aren't compensation!) I've adjusted my option cost calculation downward to reflect the tax benefit that companies receive because they deduct options on their tax returns.

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Arne Alsin is the founder and principal of Alsin Capital Management, an Oregon-based investment advisor specializing in turnaround situations. At time of publication, neither Alsin nor ACM held a position in any securities mentioned in this column, although holdings can change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Alsin appreciates your feedback and invites you to send it to [e-mail]. Click here to receive Arne's latest favorite stock picks from his newsletter, The Turnaround Report.