has elected to include employee stock options on its books as an expense, how much longer can the rest of corporate America continue to do otherwise?
Well, that depends.
Analysts and economists seem to agree on the obvious: If it doesn't significantly hurt a company's bottom line, why not include employee stock options as an expense? The
on Monday was one of the first to jump on the bandwagon, following the soft-drink maker in expensing employee stock options.
"Coke puts pressure on other companies because it puts them in a position that if they dislike it and do it, the stock price could fall. If they don't do it, will the market assume it's a negative because they're hiding something?" said Julia Grant, an associate professor of accountancy at Weatherhead School of Management. "So they're damned if they do and they're damned if they don't."
Companies have actually already been reporting the likely value of their employee stock options for years, using the Black-Sholes option pricing model and including the cost in the footnotes of their regulatory filings. However, it's up to the reader of those filings to do the calculations of how the stock options actually affect the company's bottom line.
To determine the value of Coke's stock options, the company said it will ask
to price the options as if they were up for bid. Coke will take the average price from the two firms when recording the options as an expense.
Such a strategy won't sit well with firms that rely much more heavily on stock options to compensate their employees, most notably telcos and other technology firms that worry their already anemic earnings will be swallowed up by the added cost.
In a recent study by Merrill Lynch, it was estimated that if companies incorporated employee stock options as expenses in 2001, the S&P 500's overall earnings would've been 21% lower. During the period from 1999 to 2000, the average bottom line effect would have been down 7%.
"Using our projected method for 2002, the pro forma decrease is estimated at 10%, half that of '01 as forecast EPS returns to more normalized levels," the report states.
An earlier Merrill report found that in a study of 32 technology companies, mean income would have been cut by 67% if the companies had included employee stock options as part of their expenses.
for example, would have had to report a loss of $2.7 billion in 2001, instead of the $1.01 billion loss it did post, if employee stock options were included as an expense.
Investors, who on the one hand have clamored for more corporate transparency, might find themselves less than thrilled with the newly shorn earnings reports.
Grant thinks that in light of the existing footnotes, that argument is specious. "A good analyst already has the information and incorporates it into their analysis and into their estimated stock price. Those analysts who shove the notes aside are doing a terrible job," Grant said.
The primary argument against expensing options is that they already show up as share dilution in the "diluted shares outstanding" line item of a profit-and-loss statement.
"The argument about the dilution makes no sense at all. It is compensation expense, and, as such, it must reduce profits. A company has a variety of choices to pay employees. If they choose one that involves stock and they issue new shares, it will dilute EPS. That point has nothing whatsoever to do with concerning the expensing of stock options," said Howard M. Schilit of the Center for Financial Research and Analysis.
Coke's action was applauded by Warren Buffett, who sits on the company's board. Whether anyone else follows suit remains to be seen. On Monday, Sens. John McCain and Carl Levin proposed an amendment to the Accounting Reform Bill winding its way through Congress that would require the Financial Accounting Standards Board to conduct a study expensing employee stock options and return with a recommendation within a year.
FASB, which is funded by the accounting industry, is independent of Congress. Whether the organization will recommend expensing employee stock options when certain industries have been lobbying legislators against it remains unclear. The issue, as of Monday, is not even part of the House version of the accounting reform bill.
On the other hand, scandal-plagued Wall Street could use some positive public relations.
"Shareholder pressure may lead to self-regulation by those trying to show good faith in the area of corporate governance," said the authors of the recent Merrill study. They calculated that the EPS of
would be cut by just 2% if GE adopted the practice.
, meanwhile, would see its earnings slashed by 22%.
As one Coke analyst put it, "It was a no-lose for Coke. It had little financial impact, and it was a minimal drag on earnings," he said, adding that he had not spoken to one client on Monday who didn't think Coke's move was a good idea.
After spending most of the session in the red, Coke's shares participated in the late-session rally Monday and closed up 1.55% to $51.84.