Paint Yahoo! Red on Options Costs

Supporters of the commonplace "intrinsic value" method of options accounting -- used at Yahoo! and most other companies -- argue that the alternative "fair value" method is both flawed and injurious for start-ups and for companies whose stock has sunk since options were granted. Critics of intrinsic value, in contrast, say it understates compensation expense.

Whatever the merits, the fair-value method is likely to enjoy a greater profile over the coming years. Since June 2002, more than 175 companies -- including firms representing 29% of the S&P 500's market cap -- have adopted or announced their intentions to adopt the fair-value reporting method. Those include both old-line companies such as General Electric GE and relative newcomers such as Amazon.com AMZN.

The difference is that the intrinsic-value method assigns options no cost for companies if their strike price is the same as the company's stock price when issued, while the fair-value method assesses a value based on the Black-Scholes method.

Fairness Opinion

The bottom line is that companies that continue to use the intrinsic-value method will have to report the discrepancy with the fair-value method more often than they have in the past. New rules require these companies to report their pro forma results as if they were using fair value instead of intrinsic value on a quarterly basis rather than an annual basis, with the first big wave of quarterly reports due for the quarter ending next week.

Furthermore, the adoption of the fair-value method, or some variation thereof, as the only permissible method for options accounting remains a possibility. Bear Stearns notes that the Financial Accounting Standards Board -- which is responsible for setting accounting standards in the U.S. -- launched a project earlier this month on stock options accounting. Bear Stearns suspects that FASB, which has identified fair value as its preferred method of accounting for stock options, will make the fair-value method mandatory by 2005.

In the meantime, the effect of implementing fair-value stock options accounting is widely variable but potentially large. The $483 million pro forma options expense for Yahoo! in 2002 amounts to more than half of the company's revenue for the year. Another media company, Comcast CMCSA, would have reported $143 million in additional expenses, roughly 1% of its revenue of $12.5 billion.

"We actually do believe that expensing stock options is an important step in recognizing what is a compensation cost to companies," says a Yahoo! spokeswoman. "However, Yahoo! is concerned that the current rules that cover options accounting misstate option expense. We believe that accounting policymakers and companies must develop a more appropriate way to estimate the annual cost of options before deciding to expense them."

The spokeswoman says the company is looking into what that appropriate way might be and will continue to participate in ongoing industry discussions about options accounting.