Will FASB Make Options a Less Attractive Option?

Dissent over a proposal concerning options accounting rules is growing among Silicon Valley firms.
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It's no secret that Silicon Valley's wealth rarely flows from paychecks. Most of the Valley's newly minted millionaires earn their compensation from employee stock options granted at bargain prices and later exercised at higher market values.

In an economy where good tech employees are hard to find, these stock options play a crucial role in attracting and keeping the best people. And for companies that run upon hard times, the freedom to reprice options has been a critical employee-retention strategy. Stock declines can render some options worthless, so companies can reprice them to market and keep them as an incentive to workers. Companies such as

3Com

(COMS)

and

Cendant

(CD)

have all repriced their options.

How these repricings are accounted for is a matter of some controversy. A proposal by the

Financial Accounting Standards Board

, a private entity with the authority to set U.S. accounting standards, threatens to change the way all stock options are repriced. Last week, the FASB released a draft of its proposed standards for options accounting, beginning a three-month period of public comment. If adopted, the standards will force companies that reprice stock options to report future financial results using volatile, market-dependent variable-plan accounting.

Specifically, the proposal would require any company that reprices stock options to record additional expense for the difference between a stock option's price and its market value on the financial statement date. The difference would be treated as a compensation expense, which is usually a part of a company's ordinary operating expenses.

This proposal isn't actually introducing any new requirements. Instead, it's giving a stricter interpretation to a sentence in

Accounting Practice Bulletin 25

, originally published in 1972, says Robert Traficanti, the FASB project manager overseeing the proposal. In a nutshell, the initial ruling says that companies changing option prices after the grant date will, from that point onward, use variable-plan accounting. Now, 27 years later, the FASB means to enforce that ruling more strictly.

The FASB's proposal has drawn opposition. The

Information Technology Association of America

issued a release that called the move "a real threat to the ability of high-tech companies to attract and retain skilled workers and experienced board members."

"What makes variable-plan accounting so nasty is that it pollutes the income statement with noncash expenses," says Bob Austrian, a managing director at

NationsBanc Montgomery Securities

. "Variable-plan accounting only kicks in when you have to reprice, and you only reprice when you get into trouble."

Because few public companies will risk the volatility of variable-plan accounting, the FASB measure could weaken the options-dependent tech industry's most powerful compensation vehicle.

"If a company's stock goes down substantially so that the options are way out of the money and the company can't give new options that can be repriced, then employees are likely to go to another company where they get new options in the money," says Jeff Epstein, CFO at

DoubleClick

(DCLK)

.

"This is going to make it a lot tougher for companies that have downturns to keep their best people," says Al Castino, CFO of

PeopleSoft

(PSFT)

, a company that has seen its stock drop 76% in the past year. The Pleasanton, Calif.- based software company repriced its options in December, just before the effective date of the proposed rule. "When we've repriced our options two or three times over our entire history, it's been over a retention issue," says Castino.

Before Dec. 15, 1998, companies like PeopleSoft could reset option prices made worthless by market declines without weighing down their income statements. Although a rare measure in the current bull environment, repricing maneuvers could become a more common practice were the market to turn south or suffer a protracted sideways move.

The measure will also hurt stock valuations, say opponents, as companies opting to reprice will have more complex financial statements.

"In general, investors react negatively when you have some kind of

accounting complication like this," says NationsBanc's Austrian, who says it "clouds the issue of how companies are doing."

Traficanti disagrees. "This is not going to make financial statements more difficult," says Traficanti. "I don't think it will make earnings more volatile." Asked about the employee-retention issue, Traficanti states, "That wasn't the issue the FASB was addressing."

Suprisingly, some leading technology companies are unfazed by the FASB's proposal. The CFO of a leading Connecticut-based Internet company who asked not to be named says he is "philosophically opposed to options price resets," as they frequently "reward the poor performance of upper management."