Until recently the world of accounting was to most people as 1939
This
brief but intense period of public scrutiny was followed by a flurry of
legislative activity by the two main bodies responsible for regulating
the accounting profession, the International Accounting Standards Board
(IASB) in London and the Financial Accounting Standards Board (FASB) in
the US. Among the proposals currently being discussed by both bodies is
an idea that was rejected by the US Congress in the early 1990s:
compulsory expensing of employee share option schemes. In its board
meeting later this week, the IASB will conclude a six-month review of
the issue. All the signs are the Board is ready to take the decision to
move towards mandatory expensing. This would require all companies to
include an estimate of the costs of their employee share option schemes
as an expense in their annual income statements. It would also cut off
the alternative route, currently used by most firms, of including
information about these schemes in the footnotes to their annual
accounts.
Supporters
of expensing usually present two arguments in favor of making it
mandatory. The first is a technical one, based on the presumption that
share options are an integral part of the wage costs of a company. The
inclusion of a figure for these costs in the annual accounts, the
argument continues, would be a move in the direction of producing a
more realistic annual earnings figure. Supporters of this argument
claim that this would help to make the accounts more transparent and
more reliable, which, if true, would benefit shareholders.
Cynics
might argue that it is difficult to see how merely transporting certain
data from the footnotes to the income statement itself could be
interpreted as a radical improvement of a document's transparency. A
more fundamental technical objection to expensing is that the standard
Black-Scholes options pricing model -- named after the 1997 Nobel Prize
winner in economics Myron Scholes and his colleague Fisher Black --
doesn't work with employee share options schemes. And so far, nobody
has been able to produce an acceptable alternative. Boosting investor
confidence is certainly important. But it is doubtful whether expensing
would actually achieve that. It would do little to make income
statements more transparent. And unless the experts manage to solve the
calculation conundrum, it would almost certainly make those statements
not more but less reliable.
The
second argument in favor of expensing is basically an argument against
share option schemes for executives. Echoing the technical argument,
opponents argue that such schemes hide true boardroom wage costs.
Beyond that they argue that such schemes actually offer an incentive to
executive officers to boost the value of their options artificially by
manipulating their company's earnings figures. As the Enron case made
clear, this is not just a hypothetical scenario. But mandatory
expensing would have made little difference in that particular case.
The problem wasn't in the rules but in the people applying those rules,
not least the accountants who helped to hide the abusive practices in
the Enron boardroom.
It
is correct, however, to assume that expensing would have resulted in
lower earnings figures in the case of Enron. In fact, mandatory
expensing would lead to considerably lower earnings figures for all
companies that run such schemes. A 2002 report by Merrill
Lynch showed that in 2001 mandatory expensing would have lowered
average profits for 30 major companies in the microchip industry by as
much as 70 percent. Most large companies would struggle to explain to
their investors that this artificial adjustment of their earnings
figures doesn't really reflect the underlying strength of their
operations. But for small high tech companies that usually run budgets
on a wing and a prayer, expensing would be a mortal blow. In the tug of
war for the best young graduates, these companies simply cannot compete
on salary or working conditions. What they do offer, however, is an
outside chance of striking it rich through share options if the company
makes a successful entry into the stock market. The introduction of
expensing would almost certainly mean these companies would no longer
be able to operate such stock option schemes. Without the ability to
attract the right staff, the microchip miracles of the