Proposed rules would make companies deduct cost of stock options from income Change may force showdown.

January 22, 1992|By New York Times News Service

NEW YORK -- The group that makes most of the nation's accounting rules is about to revive a long-dormant project that would force companies to deduct from their income the cost of granting stock options to their top executives.

The group, the Financial Accounting Standards Board, seems eager to correct a situation that has allowed corporations to play down their executive pay and to protect their earnings. With the issue of executive compensation heating up in Washington and abroad, the board apparently feels it can no longer afford to ignore the situation.

That is especially so now that the Securities and Exchange Commission, which oversees the board, has shown an increasingly keen interest in bringing about improvements in financial reporting.

But at the same time, the group is aware it is hurtling toward a big showdown with the executives whose companies are among its biggest financial backers.

Unlike other accounting battles where the potential impact on profits would be bigger, accounting for stock options is likely to be an emotional issue because tightening the rules could make corporate directors less generous with the companies' shares. That makes it a risky issue for the accounting board to tackle, because it derives more than a third of its revenues from voluntary donations from companies and accounting firms.

"Our constituents, certainly among the corporate executives, would like us to leave it alone," said Diana Willis, the project manager at the accounting board in charge of stock options.

An employee stock option is essentially a promise made by a company to issue a fixed number of its shares at a certain price that is good for some length of time. Current accounting rules permit companies to treat stock options differently from other types of compensation, like salaries or bonuses, which are charged to compensation expense and come out of earnings.

As long as the pre-arranged exercise price is no less than the market price on the date options are issued to an executive, companies do not need to take a charge on their books, even though the options may some day be used to buy stock at below-market prices. As a result, many companies' net income figures contain no trace of the often generous stock options their executives get.

As an example of how rich the options can prove for executives, dTC Anthony J.F. O'Reilly, chief executive of the H.J. Heinz Co., made nearly $71.5 million in the 1991 fiscal year by exercising options, in addition to the $3.6 million he received in ordinary cash compensation.

The entire executive group, including O'Reilly, according to the company's latest proxy statement, made $86.8 million from exercising heir stock options in the 1991 fiscal year, in addition to $11.1 million cash compensation.

The proxy statement was not clear on whether Heinz counted the options in its overall compensation expense, and a Heinz spokeswoman who promised to look into the company's accounting did not return a telephone call yesterday. But if Heinz is like most companies, that $86.8 million figure was not included. If it had been, the company's pretax income of $903 million would have been 9.6 percent lower that year.

While the impact would be less pronounced at companies less generous with their stock options, a leading compensation expert has concluded that U.S. corporations are overstating their income by 2 to 3 percent on average by neglecting to charge themselves anything for the stock options they award.

He expects the percentage to grow sharply, however, because of a growing tendency on the part of corporate directors to award lavish stock options in lieu of salaries or bonuses because it helps to blunt criticism of high salaries.

"The point is, while the impact may not be much, it's growing at a rapid pace because there's no discipline governing the size of the grants," said Graef Crystal, a professor at the University of California at Berkeley. "It's the one free lunch."

In a recent study of 292 major public companies, Crystal found 274 companies that had awarded stock options in 1990, to which he assigned an average present value of $13.1 million per company.

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