Hidden Cost of OptionsIf it had been required to include the cost of stock options in its reporting, eBay would have been unprofitable in three of the past five years. Although the company would have been profitable last year, taking into account options expense, its earnings would have been slashed from its reported $249.9 million, or 85 cents a share, to $62.9 million, or 21 cents a share, according to eBay's own estimates. Meanwhile, Standard & Poor's calculates that eBay's core earnings, which exclude one-time gains and charges, while including stock-based compensation expenses, were just 17 cents a share last year. In the meantime, much of the cash generated by the company has come from the issuance of stock options, rather than its actual auction business. A tax benefit related to employees selling stock options accounted for about 20% of eBay's operating cash flow last year. Combining this tax benefit with the direct cash the company raised from employees selling options, eBay's total
Ignored WarningsIn reaction to these concerns, regulators have forced companies to note every quarter how their earnings would look if they had to expense stock options. And beginning next year, regulators are likely to require companies to include options expenses on their reported bottom lines. Bowing to investor distaste and the threat of government intervention, companies such as Coca-Cola ( KO) and Amazon already have begun to voluntarily expense stock options. Other companies, such as Yahoo! and Intel ( INTC), have pledged to limit their use. In contrast, eBay has neither expensed stock options nor curtailed its distribution of them.
Complacency Rules Again"This is an uphill fight," said Harshberger, who recently served as president of Common Cause. Many investors are in denial about what happened, believing that the disasters at Enron and other companies were a function of the market downturn rather than failures of corporate governance, Harshbarger said. Despite all that's been uncovered about corporate excesses, reformers haven't been able to effect any fundamental changes in attitudes or behavior among investors or managers, he said. On Monday, Prudential analyst Mark Rowen issued a report that reads like something left over from the dot-com boom. Citing enthusiasm about eBay's just-concluded users' conference and the ability of many sellers to make money on eBay, Rowen reiterated his buy rating on eBay and raised his price targets on the company's shares from $108 to $120. Prudential has no banking relationship with eBay. Meanwhile, Youssef Squali's view is typical of many market analysts today. Squali, who covers eBay for First Albany, said he takes options dilution into account when assessing the company. But the dilution has been far outweighed by the company's financial performance, he said. Given that, shareholders shouldn't worry too much about eBay's stock options practices, he said. "It's not something we worry about as long as management is doing a good job of implementing their business strategy and creating shareholder value, as long as they deliver results," Squali said. That view belongs in fantasyland, said Gary Lutin, an investment banker and longtime corporate-governance critic.
Because eBay does not include stock options -- an important component of its compensation expenses -- on its income statement, most measures of the company's performance and valuation, such as its earnings growth or its price-to-earnings ratio, are built on illusion, he said."That's not an investment that bears up under rational analysis," Lutin said. The danger is that if the stock market continues to go up, investors' tolerance for corporate excesses may increase. "eBay can be a good example of what can happen more broadly," said Lutin, who led the charge in questioning Amazon's use of pro forma accounting methods during the dot-com boom. "A couple of years ago, this kind of thing was going on at hundreds of companies with what may have been a majority of the investment community." Meanwhile, others say some pending and enacted reforms could improve the system. The requirement that mutual funds disclose how they vote on proxy statement could focus fund managers' attention on governance issues, said Greg Taxin, CEO of Glass Lewis. "When bad things happen, people may look back to their voting," Taxin said. "If they were asleep at the switch, it won't be looked fondly upon by regulators or the plaintiffs bar -- or for that matter, shareholders." More transparency may well help, acknowledged the hedge fund analyst. But then again, investors may choose to ignore what they hear. That seems to be what happened at eBay. "People are willing to live with the problems," said the analyst. "A lot of people