Options Expensing Ripe for Abuse

Opponents of a proposed accounting change contend expensing options will end up overstating costs, leading to unfairly depressed earnings results. Ironically, a number of accounting experts worry about the exact opposite -- that some companies are grossly underestimating the value of options and thus artificially inflating their earnings.

This is not just a theoretical concern. Although U.S. companies currently don't have to include options expense in their income statements, they do have to estimate their value. Those costs -- included in footnotes in financial reports -- often appear to be dramatically understated, accounting experts say.

"What we see are companies selecting methodologies and assumptions [to value options] which vary widely," said Greg Taxin, CEO of proxy advisor Glass Lewis. "The people who are probably underestimating the cost the most are the same people who haven't yet started to expense them."

Firms Glass Lewis claims are guilty of low-balling the cost of their options include eBay (EBAY), Maxim Integrated Products (MXIM), Checkpoint Systems (CKP) and Gymboree (GYMB).

eBay represents perhaps the starkest case. In arguing against the company's plan to increase its options pool last year, Glass Lewis projected that eBay would award $1 billion worth of options in 2003.

But eBay estimated that its 2003 options grants were worth less than half of Glass Lewis' projection. Why the huge discrepancy? Taxin noted that eBay used numbers for shelf-life and risk-free interest rates that were much lower than what Glass Lewis used. Based on its estimates of those values -- and eBay's actual options grants last year -- Glass Lewis now thinks that eBay's options grants were actually worth nearly $700 million last year, or about 57% higher than eBay's own estimate.

eBay representatives did not return calls seeking comment.

Accounting Theory and Practice

The issue of how companies value options is important, because a proposed accounting rule by the Financial Accounting Standards Board, or FASB, would require all publicly traded companies to recognize options costs next year. Although the fate of that proposal is uncertain, most observers think companies will soon have to recognize at least some options costs.

Underestimating Options?
Company	*Options Granted (mln)	Avg. value per option (Co. estimate)	Gross Grant Value** (Co. estimate)	Avg. value per option (Glass Lewis estimate)	Gross Grant Value ** (GL estimate)	% Difference Between firm and Glass Lewis Estimates
Maxim	19.432732	$10.25	$199.19	20.38	$396.04	98.8%
Gymboree	1.432	6.16	8.82	8.43	12.07	36.2
Checkpoint	0.9385	3.13	2.94	6.99	6.56	123
eBay	26.694	16.31	435.38	25.55	682.03	56.7
*Most recent fiscal year. ** In millions. Sources: Glass Lewis and companies' annual reports.