Editor's note: This column originally appeared April 23 on RealMoney.com. This condensed column reflects action in the stock market on Wednesday. To sign up for RealMoney, where you can read Bill Fleckenstein's commentary every day, please click here for a free trial.
Batting Bull's-Eye Lashes
: The early-morning speculative darlings stayed hot all day, as folks can see from the box scores. Housing stocks were also quite firm. Financial stocks were pretty good participants as well. The
was basically nowhere, as there appeared to be some trepidation in front of
report tonight. But mostly, it was another winning day for the bulls. Volume on the
spiked up again, which will continue to make bulls feel warm and fuzzy. It will be interesting to see how tonight's bevy of tech reports affects tomorrow's action.
Away from stocks, the metals were a little mixed, fixed income was more or less unchanged, and the dollar saw the tiniest of bounces in basically uneventful action.
: Turning to today's news, I simply must comment on two
Wall Street Journal
articles about the expensing of stock options. In reading the first article, titled "Much Ado About Stock Options: The Epilogue," by Holman Jenkins, Jr., it is apparent that the bulls now have their own pet conspiracy theory: Those who want options expensed have an unwritten agenda to take stock prices lower. (I am not making that up, as you will see in a minute.) So, now
conspiracy theory can join the conspiracy theory favored by some stock market bears, that of the plunge protection team. It can also join the belief by some gold bulls that gold is manipulated by central banks and other interested parties.
Semiconductor Index (SOX)
Amex Gold Bugs Index
10-year Treasury Bond
Mr. Jenkins starts off his article with a completely nonsensical statement: "Hard to believe anybody still cares, but a large amount of political horsepower continues to be devoted to the question of accounting treatment for management stock options." He suggests the right response to that issue is "yawn." Then he vapors on about why it's such an absurd idea to expense options, including in his argument a particularly novel conspiracy theory:
: "The truly dangerous nuts, however, are those who see the change as a way to
correct stock prices that they believe are too high
the emphasis is mine. That is, by rejiggering the definition of 'earnings' to force companies to report a smaller number, investors will be led blindly to pay less for shares." I suppose that the people who are perpetrating this conspiracy theory will then scoop up those cheap stock prices and take advantage of the people who were dumb enough to sell the stocks to them. Do we have that right, Mr. Jenkins?
One other thing that's not quite clear to me is who the "truly dangerous nuts" are. Would that encompass anyone who believes stock-option expensing should be
, or are the nut jobs only those people who are trying to get stock options expensed in order to drive stock prices lower? Obviously, the number of people in either of those camps is radically different, since the latter camp probably contains nobody.
Then, he ends his ridiculous article almost as nonsensically as he starts it: "The market will laugh off the expensing circus with ease." Well, Holman, if that's the case, then why did you just spill a thousand words defending the practice? From there, he wraps up with what appears to be his more important agenda, pushing his conspiracy theory: "But it is worrisome that such an impulse is loose in the country's politics and media culture, this urge to 'fix' stock prices by doctoring the information that companies present to investors." If I hadn't read this article with my own eyes, I would have a hard time believing an "informed" adult could have written it.
CEO Sees Shoals in Black-Scholes
: Turning to the second
article, "'Kind of Right' Isn't Good Enough," Intel's CEO Craig Barrett makes a couple of very good points, while leaving out some other very good points. He begins, correctly, by saying, "Employee stock options do not create a cash cost like salaries or rent, and they do not have a market price since they cannot be sold. To record an 'expense,' companies would have to create an estimate for the value of the options." All that is true.
Then he goes on to talk about flaws in the method for estimating the value of the options to be expensed, noting that "Black-Scholes is the only model available." He points out that "this model was not designed for valuing employee options, instruments that are not tradable." That is correct. The Black-Scholes model was not created for this, and it shouldn't be used for this.
Harnessing Itanium-Cranium Power
: Well, if I might offer a suggestion. Intel has a lot of smart mathematicians and PhDs of all sorts. How about turning some of them loose to come up with a better pricing mechanism? Just because Black-Scholes is bad doesn't mean somebody can't come up with an improved way of estimating the cost of options. If folks were really interested in solving the problem, rather than just stonewalling, a little brainstorming might be a good place to start.
Of course, when the goal is stonewalling rather than changing things, it's always a good idea to fall back on disingenuousness. That approach comes through rather clearly, I believe, when he cites what would happen if Intel had to expense options that subsequently were underwater or where an employee subsequently left. He says if the company had to do that, it would distort its financial picture by necessitating a $3 billion charge for options that are basically worthless.
Dispensing with Estimates
: But that problem is easily resolved as well. All we have to do is only
expense options when they are exercised.
Also, if we expense them when they are exercised, we'll know what they're worth. They're worth the value of the cash an employee gets when exercising the options. We can all agree to give a free pass on valuing options when issued, and just expense them at this clear-cut cash-out value. That would take a whole lot of guesswork out of this problem, and would preserve the tax deduction that corporations currently get.
Continuing on, Barrett complains about a recent quote by Paul Volcker, that "it would be better to expense inaccurately than not at all." He finds that an inadequate reason for attempting to try. My question is, which is worse, doing it inaccurately, or not doing it at all? Reasonable people could debate that, but I think the "not at all" is worse. That said, I think I have just laid out a framework that would work.
He then goes on to point out that since he believes Black-Scholes is flawed, the results that CEOs are asked to certify would only be "kind of right," because the option expense would be just an estimate, and could be inaccurate. He says that puts him in a horrible predicament: "Since I don't believe Black-Scholes provides an accurate picture of the financial condition of our company, how can I certify our financial results using it to guesstimate the cost of options?"
Next, he adds, "
we start expensing options,
the analytical community will simply factor out the expense, using a pro forma profit and loss statement to get at the
financial condition of the company
the emphasis is mine." I think that his concern over this is at least slightly disingenuous. It seems to me that he is throwing up Trojan horses that are easily knocked down, especially when you consider that back in the mania, Intel
the charge to include stock market gains (which I called "wampum" at the time) in the continuing-operations line of its income statement. Intel has subsequently discontinued this, now that those gains have turned to losses, I might point out.
: So, he didn't seem to mind including something in the income statement that didn't belong there, but now that he's being asked to do something that he doesn't want to, he's trying to find a convenient reason not to. I see that as a misallocation of indignation, especially when he conveniently omits the fact that companies receive a tax benefit for the amount of gains their employees get -- which he has already acknowledged do not create a cash cost to the company. (For a review on this, please see my previous columns
Simmons Says No Options, No Nirvana and
Nasdaq Bull Won't Pull Wool Over Option Expense .
So, Barrett wants to have his cake and eat it, too. He doesn't want to expense options, and he doesn't even want to try to find a workable solution, it appears (though I don't mean to put words in his mouth), but he still wants to keep the sweetheart tax deduction for the amount of the employee gains. This is my problem with most of the folks who want to preserve the status quo. They want it both ways, and they make no attempt to get at the right answer.
William Fleckenstein is the president of Fleckenstein Capital, which manages a hedge fund based in Seattle. Outside contributing columnists for TheStreet.com and RealMoney, including Mr. Fleckenstein, may, from time to time, write about securities in which they have a position. In such cases, appropriate disclosure is made. At time of publication, Fleckenstein Capital had no positions in stocks mentioned although positions can change at any time. Under no circumstances does the information in this column represent a recommendation to buy, sell or hold any security. The views and opinions expressed in Mr. Fleckenstein's columns are his own and not necessarily those of TheStreet.com. While Mr. Fleckenstein cannot provide personalized investment advice or recommendations, he invites you to send comments on his column to