They used to deride it as hare-brained. Now it's taken for granted -- outside high-tech circles -- that companies should account for the cost of stock options each quarter.
The conversion of most investors, legislators and accountants to the pro-expensing camp, a long road traveled over a decade, reflects the stock market bust of 2000 and revelations of massive accounting scandals in its wake.
When talk heated up in 1993 about expensing options, Wall Street and Silicon Valley lined up solidly against the idea. Many lawmakers and the major auditing firms soon followed suit, accepting the popular argument that the accounting shift would deal too painful a blow to U.S. companies.
As a sign of the times, in 1993 the Senate voted 88-9 in favor of a resolution, sponsored by Democrat Joe Lieberman of Connecticut, warning that options expensing would have "grave consequences for America's entrepreneurs."
Against broad opposition, the lone voice in support of expensing options -- the Financial Accounting Standards Board, or FASB -- had little chance of prevailing. The fate of options expensing was sealed when a tidal wave of pro-business Republicans swept into office in 1994 elections.
By then, opposition to options expensing was proving so fierce that Securities and Exchange Chairman Arthur Levitt began to fear the FASB would be stripped of its standards-setting powers altogether. In what he now calls his biggest mistake on the job, Levitt pressed FASB to retreat from its support for a rule that would account for the cost of options in corporate income statements.
The FASB later agreed to the weaker rule that is currently in effect, which requires companies merely to make note of their options costs in financial footnotes.
Ten years down the line, many former opponents of options expensing have switched sides, demanding greater transparency in financial statements across the board. (For more about the current trends in options expensing,
Part of the change reflects more realistic assessments about the prospects of tech stocks. While investors once saw entrepreneurs as renegades who could do no wrong, they now want Silicon Valley firms to act more like any other business.
Nasdaq Composite Index
, which includes the tech sectors stars Microsoft, Cisco and Intel, fell from more than 5,000 in March 2000 to less than 1,200 in October 2003, tech shares lost their status as a magical currency, guaranteed to rise indefinitely. Long-term growth rates in the technology industry have slowed, with giants like
and the lead semiconductor trade group counseling shareowners to lower their expectations in years to come.
One legacy of the lean times is that shareholders are keeping closer tabs on how companies spend their cash. They're more inclined to question overly generous options programs, common in techland, that dilute shareholder value and drain off corporate cash flow. After all, some tech companies spend hundreds of millions of dollars a quarter buying back their own shares to offset the dilution that affects average shareholders when employees exercise stock options, increasing the number of shares outstanding.
Meanwhile, Wall Street watchers now acknowledge that the over-use of stock options encouraged some companies to use hype, and even fraud, to keep their stock prices artificially high. Executives at scandal-ridden companies like
made fortunes from options, but investors suffered tremendous cash losses after accounting irregularities were revealed.
"When you see the type of fallen market values that created a $9 trillion decline, with executives having made out with bundles because of options, it doesn't resonate very well with the average American," said Lynn Turner, the former chief accountant of the Securities and Exchange Commission who is now managing director of research at proxy firm Glass Lewis.
Now that one out of every two American adults is in the stock market, politicians are paying more attention to small investors, he added.
Big institutional investors also accept the need for tighter accounting standards. "This is a completely different environment, on the heels of terrific scandals that concern financial statements not fairly reflecting companies' financial conditions. I think the scandals really reminded folks of the importance of appropriate accounting," said Ann Yerger, deputy director of the Council of Institutional Investors, which has more than 140 members with over $3 trillion in pension assets.
The Council came out in favor of options expensing two years ago, after several years of studying the issue.
Even Wall Street giant
recently submitted a letter to the FASB in favor of expensing options, notwithstanding the firm's own involvement in accounting blow-ups at Enron and
. On May 10, Citigroup agreed to pay $2.7 billion to settle an investor suit over its role in the WorldCom accounting scandal.
Bob Traficanti, head of accounting policy at Citigroup, wrote FASB, perhaps to underscore the need to bolster investor confidence. "We would like to emphasize our strong support for private-sector standard setting, and our opposition to Congressional intervention on the accounting for stock options."
Leading accounting firms, seeking to repair their tarnished images after a spate of scandals over the past few years, have also endorsed the FASB rule outside the U.S., while momentum to expense options is growing. The International Accounting Standards Board will begin requiring European companies to expense options starting next year.
To be sure, opponents of options expensing have made some inroads into Congress, but some of the most powerful legislators are bowing to the accountants. "If the U.S. is to retain its credibility in the global marketplace, Congress must resist the temptation to interfere with FASB," wrote Senator Richard Shelby, chairman of the Senate Banking Committee, in a May 6 editorial in
The Wall Street Journal
Shelby, the gatekeeper for accounting legislation in the Senate, has said he won't hold committee hearings on options expensing -- effectively shutting down political opposition to the rule change.
"There are very influential people in the Senate who've turned around and said no
to the high-tech lobby," said Turner. "While they can buy influence on the House side, they haven't been able to buy it on the Senate side. Even though it's an election year, that's almost astounding."
Right now, technology firms are mounting a last-ditch lobbying effort to water down or delay the FASB proposal. They complain that the accounting models used to estimate the cost of options are flawed, producing inaccurate estimates of the value of options. One piece of legislation that has garnered some support on Capitol Hill would require companies to expense only options awarded to a handful of the highest-paid officers, rather than expensing options for the entire workforce.
But those who support options expensing argue that even if the models aren't perfect, they're better than the status quo, which assumes options don't cost anything at all.
For the last several months, the FASB has been taking public testimony on its proposal to require options expensing starting Jan. 1, 2005. The board plans to issue its final decision in the fourth quarter of 2004. But even though earlier attempts to limit options have failed, this time around, options accounting reform is seen as inevitable.
Mike Crooch, a member of the FASB, said expensing of options has been vigorously debated in the U.S. and worldwide. "Each time those people have all come to the conclusion that fixed price options should be accounted for as compensation. So there's going to have to be some real dramatic and unknown fact come up before it will not happen," he said.