Prolific dispensers of stock options, particularly in high-tech industries, have fought bitterly against having to show the cost of those grants. But now dozens of them have found an easy way to wipe those expenses off their books -- at least for now.
These companies are speeding up the vesting of the options they've handed out to employees and executives. By making sure those options vest before June, they can avoid showing them as an expense on their earnings statements.
Reports of companies taking this route have trickled out in recent months as accounting regulators considered and then decided to mandate the expensing of stock options. In a report last week, Bear Stearns tallied up the numbers: Some 102 public companies have decided to accelerate the vesting of at least some of their outstanding options. By doing so, those companies have avoided having to show $1 billion of options costs once expensing starts, Bear Stearns estimated.
"We expect more companies to announce such actions as we approach the effective date" of the expensing rule, Bear Stearns analyst Pat McConnell said in the report.
Some 36% of the companies that have chosen this tack are in the options-enamored tech industry. But companies that are speeding the vesting of their stock grants come from all sectors of the economy. Among them:
Noven Pharmaceuticals , which Monday said that it accelerated the vesting of some 932,000 out-of-the-money options, including about 401,000 held by the company's executive officers.
Viacom , which last month sped the vesting of 29 million underwater options, including 5 million held by executives. The move wiped out a potential post-tax expense of $242 million, which represents nearly 30% of what the company would have earned from its continuing operations last year if not for an $18 million writedown of goodwill.
Linear Technology , an analog chipmaker, which earlier this year announced it was accelerating the vesting of about 4.5 million out-of-the-money options, thereby avoiding a $75 million charge on its income statement.
The accelerated vesting is perfectly legal. Both the
Securities and Exchange Commission
and the Financial Accounting Standards Board have signed off on the practice. But many accounting experts and corporate governance activists have criticized the practice.
"It's appalling," said Nell Minow, editor and founder of the Corporate Library, a research firm that focuses on governance issues. Institutional investors are already saying that the issue could encourage them to withhold votes from corporate directors, she said. "It shows bad faith and bad judgment on the part of
The move to speed vesting is one of the predictable -- if unintended -- consequences of the move to force companies to expense options, said Peter Lawson, director of congressional and public affairs at the U.S. Chamber of Commerce. And with at least some companies choosing to speed vesting, others are going to find themselves with a difficult decision, he said. They can either speed vesting and come under criticism from shareholder activists such as Minow, or do nothing and have shareholders wonder why their earnings are so much lower than those of competitors who did speed up the vesting of their options.
"You're putting those companies in that situation in a tough spot where they could be criticized either way," he said.
That accounting regulators left open a loophole in their new expensing rule is ironic, considering that the rule itself was intended to close another hole in accounting rules. Under the current accounting regime, companies can choose whether or not to show options costs on their income statements. Many have chosen not to, merely showing them as a footnote in their financial statements.
Options grants allow company insiders to buy stock at a set price, usually with the intention of selling immediately at a higher market price. In general, employees can't exercise their stock options until they become active, or vested. Usually a quarter or a fifth of an option grant will vest after a year, with the remaining vesting in even installments over the next three to four years.
Companies that grant options must determine their value on the grant date, but they don't have to show the cost of those options until they actually vest.
The new accounting rule, which takes effect June 15, will require companies to include their options expense in their reported income statements for fiscal periods following that date.
The only stipulation made by accounting regulators on companies that choose to speed the vesting of their options is that they give a detailed reason for the move. Noting that they plan to cut back on their future grants, some companies have argued that having to show the cost of their more prolific previous grants would be misleading. Others have argued that the shares they must expense are so far underwater that they will never be exercised.
But many companies have been unabashed at explaining that the key reason for speeding up the vesting is to avoid including the cost of those options in their reported earnings. Because the key factor in when to recognize the expense is when the options vest, companies can hide that expense in their financial footnotes as long as the options vest before June.
Last week, for instance, Micron Technology said that it would
speed the vesting of 44.6 million of its outstanding stock options. Those options are worth some $100 million, which represents nearly two-thirds of Micron's net income last year. That charge will now never show up in Micron's income statement.
"The purpose of the accelerated vesting was to enable the company to avoid recognizing future compensation expense associated with these option," Micron acknowledged in a statement.
But this may be only a short-term fix. Many companies intend to continue handing out options even after they have to start recognizing their expenses. After wiping the costs of their previous grants off the books, those companies will likely see a steady climb in options charges in coming years.
"The longer-term impact
of accelerated vesting is that it will take longer for
companies' financial statements to be accurate," said Minow.
Although most companies that will speed the vesting of their options have chosen only to accelerate those grants that are underwater -- i.e., having a strike price above the current market price -- not everyone has. According to Bear Stearns, 12 companies have said that they would vest even options that are above water, and thus likely to be exercised in the near term.
, for example, said earlier this year that it planned to accelerate the vesting of nearly all of its outstanding grants. As of the end of last year, those options were above water -- meaning that the market price for Whole Foods' stock was above the exercise price for the average option -- to the tune of $282 million, according to Bear Stearns.
Whole Foods representatives did not return calls seeking comment, but the company previously said it was speeding the vesting of its options to avoid having to record past grants on its income statement. While the company plans to cut back on the number of options it hands out, it intends to continue offering options to employees and executives throughout its company.
Regardless of the rationale behind the move, accelerated vesting of options is a boon to corporate employees -- and executives, said Jeff Brotman, a professor of accounting at the University of Pennsylvania's law school and managing partner of Ledgewood, a Philadelphia-based law firm. Companies that are speeding vesting are reminiscent of those that repriced their stock options after the stock market crashed -- a move that many investors frowned on, he said.
"It reinforces the image that I thought we were trying get away from, that there's no downside" to options, Brotman said.
To be sure, some companies that have sped the vesting of their options have set different terms for executives. Executives at Viacom, for instance, can exercise their early vested options whenever they want, but they can't sell the shares they acquire from them until their options would have vested or until they leave the company. Whole Foods said it would not accelerate the vesting of options held by directors and executives.