End the options free lunch

April 16, 2004

FED CHIEF Alan Greenspan and Treasury Secretary John W. Snow are for it. Coca-Cola does it. Even Microsoft has jumped on the bandwagon. All have rejected the accounting logic enabling companies to avoid taking an immediate expense for granting stock options - a device allowing firms to show off much rosier earnings.

So why is Congress - led by House Speaker Dennis Hastert and Minority Leader Nancy Pelosi - once again about to thwart a move by accountants' leading private standard-setter to enforce financial transparency on the cost of options to corporations and their stockholders?

The answer is the same as in 1994, when the independent Financial Accounting Standards Board (FASB) last proposed the change and Congress voted against it: Lobbying by big corporate donors, concentrated in the tech sector and Silicon Valley, who continue to claim - without strong evidence - that being forced to treat options as an expense would somehow deter innovation and hurt the American economy.

After the late 1990s' stock bubble burst and a long list of corporate accounting scandals leaked out, Congress has moved aggressively to try to stiffen corporate financial reporting. This sort of congressional intervention, however, would be a big step backward for the multipronged effort to prevent corporate abuses and restore credibility to the nation's financial markets.

Since the mid-1990s, companies have had to account for the cost of granting options, but only in footnotes following their financial statements. If this expense were reflected in the profit statements of the companies that constitute the Standard & Poor's 500, their collective earnings would have been 8 percent lower in 2003 - even though more than 100 of these firms already have shifted to expensing options. Among firms listed on the tech-heavy NASDAQ market, where few expense options, overall earnings would have been more than 40 percent lower last year.

It's hard to argue against more accurate reporting of earnings, particularly when a recent analysis by the Congressional Budget Office cast doubt on the assertion that expensing options would hurt the overall economy or startup firms' ability to raise capital. Stock prices of companies that recently began treating options as an expense have tended not to take hits.

Financial markets' credibility and health would be best served if options were treated as an expense and Congress respected the independence of the FASB.

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