At long last, the Financial Accounting Standards Board laid out a proposal Wednesday that would require public companies to expense stock options. Many hope that a final rule can be in place by the end of the year, but the decade-old campaign still has one more obstacle to cross: Congress. In the mid-1990s, when accounting regulators last seriously considered forcing options expensing, opponents in Congress forced FASB to back down. Now the technology industry is pressuring legislators to throw up another roadblock. Congress already has started considering such a measure, and the release of FASB's proposal is a "galvanizing moment" that will spur legislators to act, said Jeff Peck, who is lobbying against broad options expensing on behalf of technology companies and workers. Forcing companies to expense stock options for rank-and-file workers -- as FASB's proprosal would do -- will cost jobs, Peck argued. In the context of a jobless recovery, few politicians will want to be portrayed like that. "I think election-year politics are very significant on this," Peck said. "If rank-and-file workers are going to complain about expensing, it's not like they're going to go to polls and throw out the members of the FASB." That prospect -- plus the money the technology industry may be willing to throw at the issue -- has already won over some in Congress. A bill that would block the expensing of options issued to everyone but companies' top five executives has already gained the support of some 70 members of the House, including Speaker Denny Hastert (R., Ill.) and Minority Leader Nancy Pelosi (D., Calif). Indeed, many in Congress believe that options expensing is a dubious proposal and many of the most important members are sympathetic to the technology industry on the issue, said James Lucier, a senior Washington analyst for Prudential Equity Group. Even after the stock market bust, Congress still treats technology CEOs with the reverence usually reserved for rock stars, Lucier said. "The industry has been very successful in making its case," Lucier said. "All other things being equal, Congress would opt in that direction if it were up to them." But all things aren't equal, Lucier noted. An array of forces is pushing in favor of options expensing. The International Accounting Standards Board will soon require options expensing. The fallout from the corporate scandals at Enron, WorldCom and other companies -- attributed in part to the use of stock options -- still hangs thick in the air in Washington. And expensing opponents are battling perhaps an even more difficult opponent: inertia. "In the post-Enron climate, Congress is very risk-averse when it comes to intervening in the standard-setting process," Lucier said. "Congress would rather not touch accounting issues with a 10-foot pole."
FASB's latest options proposal has two main elements: that publicly traded companies be required to use a fair-value method of valuing options granted to employees, and that the value be subtracted as a business expense on companies' income statements. FASB has now opened the proposal up for public comment. The accounting group expects to issue a final rule this fall that would take effect in mid-December. Currently, accounting rules allow public companies to expense options using the "intrinsic value" method, which is just the exercise price minus the price of the underlying stock. Because most stock options have an exercise price equivalent to the stock's market price when they are granted, they have no intrinsic value, and companies that use the intrinsic value method typically recognize no options expense. In contrast, fair-value methods of expensing attempt to estimate the lifetime value of each option issued. At present, companies only have to disclose the fair-value cost of their stock options in a footnote within their federal filings. To forecast options' fair value, companies can use a number of formulas that take into account factors such as the company's underlying stock price, the volatility of the stock and the expected shelf life of the options. Many companies use the Black-Scholes method to estimate options costs in their footnotes, but in its proposal FASB expressed a preference for a binomial, or "lattice model," method. (The differences between the two models are mathematically complex but come down to the way different variables affect one another. In the lattice method, for instance, a stock's nearness to a strike price affects the model's time variable because an owner is deemed more likely to exercise the option.) However, the accounting regulator declined to require companies to use one method or another, noting that the lattice model may not be appropriate for all companies. Technology companies and other options-expensing opponents have argued that all current fair-value expensing methods are wildly inaccurate. Many companies issued options at the height of the stock market boom, and they will never be exercised. But if options expensing had been in place, companies would have had to recognize large charges for those grants, critics note. The resulting depression in reported earnings would have been as misleading as if they hadn't reported any options expense, they argue. Critics also worry that if companies are forced to expense options, many will abandon them instead of reporting earnings-busting charges. That could hurt companies' ability to hire workers, as they'd be forced to substitute options grants with higher salaries or bonuses, critics argue. If U.S. salaries go up to compensate for lost options, companies will be forced to outsource more jobs, technology companies and their allies warn. "It doesn't seem like a good idea to punish smaller companies and employees of smaller companies who are willing to take stock options in lieu of cash right now," said Michael Diresto, a spokesman for Rep. Richard Baker (R., La.), who co-authored the bill that would block expensing of options granted to nonexecutives.
But not everyone buys that argument. Proponents of options expensing argue that the issue is about honesty in accounting. Regardless of whether stock options are granted to employees or executives, they represent an expense that should be recognized on company income statements. And the argument about jobs may fall on at least a few deaf ears in the halls of Congress. Even though they aren't yet required to expense options, technology companies are already shifting thousands of jobs overseas. Indeed, many in Congress may be reluctant to stick out their necks to help the technology industry, said one Senate aide, who asked not to be named. Many have come to see the stock options as an issue that affects a handful of companies primarily located in California, the aide said. With some 500 companies already voluntarily choosing to expense options, the technology companies will have a hard time convincing legislators that they should be treated differently. "An awful lot of people are saying, 'Let's stop the games,'" the aide said. "Most people see expensing as inevitable."