Stock Options

1
Stock Options
2

• Earnings are everything, the solid reality of
  the bottom line that we use in our financial
  models to determine a companys value. Yet the
  are also mere fictions, tales that weve agreed
  to believe as long as they follow certain widely
  accepted conventions.
• --The Motley Fool, Friday, July 18, 1997
• www.fool.com/Rogue/1997/Rogue970718.htm

3

• Current accounting standards require firms to
  recognize as an expense the value of the
  compensation they provide in the form of employee
  stock options. For some types of options,
  however, firms can choose how to measure that
  value.

4

• The can use the immediate-exercise value
  (intrinsic value), which is usually zero, or an
  estimate of the fair value, which is almost
  always greater than zero.
• According to the CBO, the practice of using the
  intrinsic vale results in overstatement of
  reported net income.

5

• March 12, 2003 - Not unexpectedly, the Financial
  Accounting Standards Board (FASB) decided to open
  a new project on employee stock options

6

• At their April meeting, the FASB voted to require
  expensing of stock options.

7

• The FASB move is similar to the stance taken by
  the IASB, and both groups are receiving
  significant pressure to back down.
• On July 20, 2004, U.S. House of Representatives
  passed a bill to limit expensing of stock options.

8

• The bill, the Stock Option Accounting Reform Act
  (H.R. 3574), mandates the expensing of stock
  options granted to the CEO and the next four most
  highly compensated officers of a company but
  exempts the expensing of stock options for all
  other employees.

9

• However, the Senate has failed to act on the
  Bill, so it appears that legislative efforts
  aimed at stopping the requirement to expense
  options have failed.
• The SEC has supported the FASB rules while also
  allowing companies some flexibility.

10
Stock Options

• An option gives the holder the right, but not the
  obligation, to buy a share of stock in the future
  at a predetermined price. The more the stock
  price rises, the more valuable the option becomes.

11
Terminology

• Option a contract to buy stock at a specified
  price
• Option Price the amount you pay for the option
  (which may be zero, or a nominal sum)
• Exercise price, or Strike price the price at
  which the option owner can purchase the stock
• Expiration date the final date on which the
  option owner can purchase the stock

12

• If an owner buys the stock, the owner is said to
  exercise the option. Normally, options are only
  exercised when the market price exceeds the
  strike price.
• The date the option is awarded is called the
  grant date.
• To gain final ownership, the employee may have to
  stay with the company for a period of time, the
  vesting period

13
Qualifying Stock Option Plans

• An incentive stock option allows the employee to
  purchase stock in the future at a price no less
  than the fair market value at the grant date.
• An employee stock purchase plan, which must be
  open to all employees, allows the purchase of
  stock at up to a discount of 15 from the current
  fair market value.

14
Non qualifying stock option plans

• Any option contract that doesnt qualify as an
  incentive stock option or an employee stock
  purchase plan is considered a non-qualifying
  plan.
• Qualified stock option plans receive preferential
  tax treatment.

15

• Purpose to align interests of management, and
  sometimes employees, with interest of absentee
  owners the stockholders

16

• The average CEO at one of the nations largest
  companies has been earning about 2 million a
  year in cash compensation, but an additional 10
  - 15 million in options.

17

• Does this create any incentives for management?
• One fear is that our reliance on stock option
  compensation has inordinately caused company
  management to focus on actions to drive up the
  price of their stock in the short term in order
  to provide continuing value for their option
  programs.

18
New Rules Expense Stock Options

• Pursuant to the SECs Final Rule Release dated
  April 21, 2005 registrants that are not a small
  business issuer will be required to prepare
  financial statements in accordance with FAS
  123(R) beginning with the first interim or annual
  reporting period of the registrants first fiscal
  year beginning on or after June 15, 2005.

19

• That makes a great deal of sense, rather than
  forcing them to expense stock options before the
  beginning of their fiscal years, says former SEC
  chair Arthur Levitt.

20
Current Accounting

• Options are not expensed, and do not appear on
  the income statement.
• Does this mean options do not have a value????
  (What do you think CEOs would say?
• Can the value be estimated?
• Black-Scholes, option pricing models

21

• An area of significant contention is that the
  current valuation models may be misleading.

22

• In diluted eps, the effect of potential exercise
  of the options increases the shares of stock
  outstanding used in the denominator of the eps
  calculation. The dilution of equity is therefore
  formally disclosed.

23

• Pro forma net income must be disclosed in the
  footnotes to the financial statements to show the
  impact of options on net income if they had been
  expensed at the grant date.

24
Business Week, July 14, 2003

• If 2002 is any indication, expensing options
  will likely have a huge impact on profits,
  slicing 20 off reported earnings

25
CNET News.Com July 23, 2003

• If stock options had to be expensed and disclosed
  on the income statement
• Siebel Systems would have reported a loss last
  year of 467 million dollars instead of a profit
  of 255 million.
• Amazon would have seen their net loss increase
  from 567 million to 963 if they had expensed
  options

26
Tax Treatment

• For non qualifying stock options, the issuing
  company may get a significant tax benefit.

27
Example (Professor Gary Maydew)

• Assumptions
• Co. has 1 million shares outstanding with a total
  FMV of 10 million (10 per share), with a par
  value of 2 per share.
• CEO is granted 100,000 nonqualified options to
  acquire stock any time in a five-year period at
  an option price of 12 per share. At time of
  grant, the estimated fair market value of the
  options is 400,000 (4 per share).
• Earnings for years 1 and 2 without regard to
  the options are 1.5 million and 2 million
  respectively.
• At the end of year 1, FMV of stock is 11 per
  share. At the end of year 2, when the FMV of
  the stock has risen to 18 per share, CEO
  exercises all of the options.

28
If options are NOT expensed

• Granting of the options No entry on books (except
  memo entry)
• EPSyear 1
• 1,500,000/1,000,000 1.50 per share
• The stock options do not figure into the
  denominator, because if exercised, the effect
  would be anti-dilutive, i.e., EPS would increase.
  (the option price is above the market price)

29

• Exercise of the options
• Cash 1,200,000
• Common stock 200,000
• Paid-in capital 1,000,000
• EPS year 2
• 2,000,000/ 1,100,000 1.82 per share

30

• The options would have been included in the
  denominator whether or not exercised, because the
  effect is dilutive (FMV of the stock is above the
  option price)

31
If Options ARE Expensed

• Granting of options
• Compensation expense 400,000
• Paid-in capital 400,000
• EPS
• year 1 (1,500,000-400,000)/1,000,000 1.10
  per share

32

• Exercise of Options
• Cash 1,200,000
• Common stock 200,000
• Paid-in capital 1,000,000
• EPSyear 2
• 2,000,000/ 1,100,000 1.82 per share

33

• Observations Intel Letter to Shareholders
• Bryant asserts that because stock options are a
  non-cash expense, and involve an element of
  subjectivity in their measurement, that the
  information would be unreliable.

34

• However, companies make all sorts of subjective
  estimates to arrive at their net earnings (e.g,
  amortization, bad debt losses, obsolescence of
  inventory, impairment). The trade-off is between
  absolute accuracy and relevance, and the
  accounting profession decided in favor of
  relevance many years ago.

35

• If, for example, Intel purchased advertising from
  CBS and paid them in stock options, there would
  be absolutely no question that the transaction
  should be recorded (Dr. Advertising Expense, Cr.
  Paid-in capital). Why is compensation to an
  employee in stock options any different?

36

• Bryants letter boasts that Intel, presumably
  moderate in its use of stock options, keeps its
  potential dilution "below an annual average of 2
  percent of the total shares outstanding."
• However, if one reads the 10K report, the
  dilutive effect of expensing stock options in
  2002 would have reduced EPS from .46 per share
  down to .29 per share, an almost 40 percent
  reduction.

37
The Case of Microsoft

• A significant portion of the wages Microsoft
  formerly paid to its employees came in the form
  of stock options rather than in cash. Compared to
  the rest of the industry, the amount of cash
  Microsoft pays its programmers is at best
  mediocre. It attracts and retains employees via
  stock options.

38

• At one time, Microsoft essentially guaranteed
  their employees that they would be millionaires
  if they worked for the company for 4 yearsand
  this wealth was not based on the salary they
  earned!

39

• Options give the employees the right to buy a
  certain number of shares of Microsoft stock at a
  tiny fraction of the current market price.

40

• Employees can even take an automatic payroll
  deduction to make the token payment to exercise
  each stock option as it matures, and thus
  effectively get shares of Microsoft stock as part
  of their wages (because the stock has appreciated
  substantially since it was granted at an exercise
  price equal to the market price several years
  prior).

41

• Microsoft's options are "non-qualified," which
  means the employee is immediately taxed when an
  option is exercised (i.e., used to actually
  purchase very cheap stock). The difference
  between the price the employee pays for the stock
  and the current market price for the stock they
  receive is counted as taxable income on the
  employee's W-2 tax form for the year, as if
  they'd received it in cash

42

• Because the employee is taxed on this amount as
  income, the government allows Microsoft to deduct
  this amount as compensation expense when
  calculating Microsofts taxable income.

43

• In 1999, the additional compensation expense
  generated a 3.1 billion tax savings for
  Microsoftconserving 3.1 billion in cash that
  Microsoft otherwise would have had to pay to the
  government.

44

• The purpose behind this tax legislation was to
  encourage stock options plans because, as well
  discuss later, many feel that these plans provide
  important incentives and benefits for corporate
  growth.

45

• Microsoft has a marginal tax rate of about 35,
  so this tax savings represented about 9 billion
  in compensation expense that Microsoft was
  allowed to deduct because employees had paid
  taxes on this amount.
• But Microsoft didnt have to pay ANY of this
  compensation in cash, and did not record the
  expense on the income statement.

46

• Its employees got taxed and paid that tax out of
  their own cash wages, and Microsoft got the money
  refunded back into its corporate coffers.

47

• Given that Microsoft had about 7.8 billion in
  net profit, the potential 9 billion in expense
  would have changed their position from a net
  profit to a net loss.
• But rememberthey didnt pay the compensation in
  cash, and the dilutive effect of the options was
  disclosed in their eps calculations.

48

• Not only did Microsoft save significant taxes,
  they collected 1.3 billion of cash from its
  employees in that payroll deduction to that
  employees used to purchase the options.

49

• Microsoft prints stock, pays its employees with
  the stock, and the stock market provides the cash
  for Microsoft's employees when they sell the
  stock or get margin loans against it. Microsoft
  can print as much stock as it likes in order to
  pay its employees, and as long as the market
  keeps wanting to buy shares from those employees,
  then Microsoft doesn't have to spend too much of
  its own cash to pay its people. As of July '99,
  Microsoft had around 60 billion of employee
  stock options outstanding.

50

• A company that uses a stock option plan similar
  to the one Microsoft uses does have to deal with
  the dilutive effect of the shares of stock
  represented by the option plans. As long as
  income (productivity) are rising, the dilutive
  effect may be minimal.

51

• Orwith the cash they generate from the employee
  stock options via the purchase price and the tax
  savings, the company can buy back the shares of
  stock on the open marketreducing the shares of
  stock outstanding.

52

• It is possible, then, for the company to
  essentially buy back the shares, potentially
  giving the cash to the employees that exercised
  the options and then sold their shares.

53

• But the purchase of treasury stock is NOT an
  expense on the income statement.

54
Greenspan

• the very complexity and dynamism of our system
  requires that we constantly evaluate the tools
  employed for measuring corporate performance to
  ensure that they adapt appropriately to the
  evolving financial and economic environment. In
  that regard, the increasing use of stock option
  grants to employees has raised new challenges for
  our accounting system.

55

• Such options are important to the venture capital
  industry, and many in high-tech industries have
  counseled against making any changes to current
  practices.

56

• They argue that the use of options is an
  exceptionally valuable compensation mechanism
  that recognizing an expense associated with these
  grants would reduce the use of options, harming
  high-tech companies that the effect of options
  on fully diluted earnings per share is already
  recognized and that we cannot measure the costs
  of options with sufficient accuracy to justify
  their recognition on financial statements

57

• The seemingly narrow accounting matter of option
  expensing is, in fact, critically important for
  the accurate representation of corporate
  performance

58

• A stock option is a unilateral grant of value
  from existing shareholders to an employee.

59

• The grant is made to acquire the services of the
  employee, and presumably has a value equivalent
  to the cash or other compensation that would have
  been required to obtain those services--what
  economists call the opportunity cost of employing
  those services

60

• That value is obviously a function of when, and
  under what conditions, the option can be
  exercised. To assess the cash equivalent of the
  option, only the market value of the option at
  the time of the grant matters. Subsequent changes
  in the value of the option are not relevant to
  the exchange of labor services for value
  received, just as future changes in the
  purchasing power of cash received for services
  rendered do not affect the firm's compensation
  costs.

61

• The accurate measurement of input costs is
  essential for determining whether the corporation
  earned a profit from its current activities.

62

• To assume that option grants are not an expense
  is to assume that the real resources that
  contributed to the creation of the value of the
  output were free. Surely the existing
  shareholders who granted options to employees do
  not consider the potential dilution of their
  share in the market capitalization of their
  corporation as having no cost to them.

63

• The particular instrument that is used to
  transfer value in return for labor services is
  irrelevant. Its value is not

64

• One may argue that, because option grants are
  fully disclosed (in the footnotes) and their
  effect on earnings can, with some effort, be
  estimated reasonably well, financial markets in
  their collective wisdom see through the nature of
  any bookkeeping transactions. Hence, how expenses
  and profits are reported is of no significance,
  because nothing in the real world is altered.

65

• Cash flows, for example, are unaffected. The
  upshot of this reasoning is that stock prices
  should be unaffected by whether option grants are
  expensed or not.
• Clearly, most high-tech executives believe
  otherwise.

66

• The measure of diluted earnings per share
  currently reported by corporations partially
  reflects the number of shares that employees
  could obtain with vested but, as yet, unexercised
  options. Some have maintained that this is all
  that is required to capture the effects of option
  grants.
• This adjustment corrects only the denominator of
  the earnings per share ratio. It is the
  estimation of the numerator that the accounting
  dispute is all about.

67

• Some have argued against option expensing on the
  grounds that the Black-Scholes formula, the
  prevailing means of estimating option expense, is
  approximate. It is.
• But, so is a good deal of all other earnings
  estimation. Moreover, every corporation already
  implicitly reports an estimate of option expense
  on its income statement. That number for most
  companies, of course, is exactly zero

68

• The continued popularity among employees of
  option grants as a substitute for cash
  compensation requires a persistent expected
  uptrend in a company's stock price.
• Should compensation shift more to cash, the trend
  in reported earnings growth would decline
  relative to an earnings trend in which options
  have always been expensed.

69
Other Issues

• Options also received a further boost when
  Congress passed the 1 million cap legislation in
  1993, which placed a cap on tax deductions for
  nonperformance-based pay to a company's top five
  executives.
• Stock options with an exercise price of fair
  market value or higher on the grant date
  qualified as cap-exempt performance-based
  compensation, while service-vested restricted
  stock did not.

70

• Employees who receive stock options may not be
  faced with the same risk of ownership that other
  equity owners face. When stock options are out
  of the money, a corporation may either reprice
  the options or cancel the options and issue new
  options with a lower strike price.
• This is not a benefit available to other equity
  shareholders!

71

• Repricing also raises the question of whether the
  issuance of options really does align management
  interests with those of stockholders.
• No longer do stock options mean that executives
  or other employees will only gain if shareholders
  gain.

72

• One problem is that stock options, as currently
  structured, often provide only a loose link
  between compensation and successful management.
• A company's share price, and hence the value of
  related options, is heavily influenced by
  economy-wide forces--that is, by changes in
  interest rates, inflation, and myriad other
  forces wholly unrelated to the success or failure
  of a particular corporate strategy.

73
The Opponents

• As chief human resources officer at Sun
  Microsystems, the story I've seen unfold over the
  past few years is this Most stock options are
  not going to executives. In fact, more than 85
  percent of Sun's stock options are distributed to
  rank-and-file workers
• So, to me, the story of stock options is
  primarily one of people working hard, knowing
  that if the company does well, so will they
• Stock options are not a guarantee, but they are a
  powerful motivator, and that's a large part of
  their value to companies, their employees, and
  their stockholders.

74

• Currently, U.S. companies have a choice to either
  list stock options as an expense or disclose them
  in financial statement footnotes, which provide
  more information for investors. Most companies,
  including Sun, choose the latter, and with good
  reason Since there's no accurate way to predict
  the eventual value of stock options when they're
  issued -- no way to even know whether they will
  ever be vested and exercised -- there's no way to
  state the expense accurately. In fact, it
  requires guess work -- and creates an unintended
  but very real potential for manipulation and
  abuse.

75
NCEE Data

• The National Center for Employee Ownership
  estimates that employees control 8.3 percent of
  total U.S. corporate equity, or 663 billion, up
  from less than 2 percent just a decade ago.
  Employee stock-option plans account for at least
  200 billion of that total, and as many as 7
  million employees participate in some 3,000
  plans. A decade ago, only 1 million U.S.
  employees had them.

76

• The high-tech industry's generosity with stock
  options in the 1990s enabled rank-and-file
  workers at the 100 largest Internet-based
  companies to cash in an average of 425,000 each
  in stock-option profits, according to new
  research.

77

• As far as we can determine, never before in the
  history of the modern corporation has an entire
  industry handed over so much potential ownership
  to a broad cross section of employees,'' write
  Rutgers University professors Joseph R. Blasi and
  Douglas L. Kruse and Business Week reporter Aaron
  Bernstein.

78

• Even when tech stocks were melting down in 2000
  and 2001, workers below top management pocketed
  an estimated 25 billion -- or an average of
  125,000 -- at companies that ranged from
  stalwarts such as Cisco Systems and Yahoo to
  flame-outs such as Excite_at_Home and Portal
  Software.

79

• That came on top of an estimated 53 billion --
  or 300,000 each -- that workers netted from
  options during the tech boom the previous six
  years.

80

• Although those estimates could rankle investors
  who lost money in those companies, the authors
  contend that broad-based stock-option plans were
  one of the best innovations to come out of the
  tech industry in the 1990s.
• As they see it, stock options give ordinary
  workers a compensation two-fer the chance to own
  a long-term stake in their company and take
  short-term profits

81
July 15, 2003 AeA (the nations largest
high-tech trade association)

• More than 220 small and mid-sized companies
  signed an AeA letter to Congressional leaders
  today asking for the passage of the Broad-Based
  Stock Option Plan Transparency Act of 2003.

82

• According to William T. Archey, AeA president and
  CEO, The FASB proposal to expense stock options
  will hurt rank-and-file employees ability to
  participate in the ownership of their own
  company.
• These smaller high-tech companies need stock
  options for attracting and retaining the most
  capable workers.
• Stock options, given to the vast majority of
  their employees, provide these companies with a
  competitive edge for keeping skilled workers.

83

• The legislation is critical to slowing the rush
  to judgment and for giving accounting regulators
  the time they need to evaluate the full range of
  economic and accounting issues surrounding stock
  option plans.

84
Claims of shortcomings

• Requires accounting practices that will obscure
  the real performance of the company
• Provides no flexibility for companies to
  determine the best way to inform shareholders and
  investors of accurate financial performance. No
  single approach works for all companies.

85

• It will force companies to use what is likely a
  meaningless value for stock options. FASB has
  acknowledged in the past the difficulty of
  valuing stock options.
• It will actually lead to less information in
  financial statements that is currently available
  and give a misleading view of a company. We need
  more transparency, not less.

86

• A survey conducted by AeA last year found that
  public high-tech companies on average grant stock
  options to 84 percent of their employees. The
  survey also revealed that a full 60 percent of
  public high-tech public companies provide stock
  options to all employees.

87
But Is this Good or Not?

• You can look at the numbers and just by the
  math you know that a lot of people made a lot of
  money. But the question is, were these the right
  people?'' said David Yermack, an associate
  finance professor at New York University who
  studies stock options. Are these the people who
  created shareholder value? Or are they the people
  who came on board at the right firm at the right
  time?

88

• The problem with options,'' he said, is that
  sometimes they create more of a short-term
  mentality.''

89

• Portal Software of Cupertino boasted of creating
  350 millionaires, even though it has lost
  virtually all its value since the stock market
  peaked in March 2000 and has never posted an
  annual profit.
• A Mercury News examination in December showed
  that 21 Portal insiders cashed in 704 million in
  stock, led by founder John Little, who unloaded
  127.5 million of shares.

90

• The National Center for Employee Ownership
  estimates that employees covered by broad-based
  stock-option plans receive an amount equal to
  between 12 and 20 percent of their salaries from
  the "spread" between what they pay for their
  option stock and what they sell it for.

91

• According to accounting professor Terry Shevlin
  at the University of Washington, there is little
  evidence of widespread mistreatment of stock
  options by the countrys top corporate managers
  despite the highly publicized scandals involving
  former officials at Enron, Global Crossing and
  Worldcom.

92

• Rather, he says, a study of more than 1,000
  corporations shows that for every dollar in stock
  options given to a companys top managers, that
  firms earnings go up an average of 2.85 during
  the next five years.

93

• Others state that investors deserve more accurate
  and reliable financial statements, and these
  opponents believe that requiring companies to
  count stock options as expenses will not give
  investors the information they need.
• Rather, expensing options would be bad
  accounting policy it would incorrectly treat
  options the same as corporate cash expenses and
  require companies to use valuation methods that
  are known to be inaccurate and misleading.

94

• An option does not "expense" any asset of a
  company it dilutes the ownership of existing
  investors, but does not take cash out of the
  company. So the common sense and proper
  accounting for options should be to show the
  dilution in the company's equity tables.
• From this perspective, the transfer of wealth
  from other shareholders to employees is not a
  transaction of the corporation.

95

• Further, many claim that the Black-Scholes
  formula, the most frequently used valuation
  method, produces highly misleading results that
  often significantly overstate the value of
  employee stock options.

96

• The formula may be particularly problematic for
  companies with volatile stock prices, such as
  high-tech, emerging growth companies. For
  example, one company has found that the "value"
  of its employee stock options could swing by more
  than 350 million--roughly 50 percent--by subtly
  changing just two variables in the Black-Scholes
  equation volatility by 15 percent and the
  "average life of the option" by just one year.

97

• When deciding on Black-Scholes assumptions,
  companies are supposed to rely on historical
  experience, modified with a little common sense
  about what the future is likely to hold.

98

• For example, when estimating option life,
  companies are supposed to consider not only
  historical data on option exercises but also
  factors that may affect future exercises. Capital
  One Financial (COF ) Corp., for example, reduced
  its option life expectancy in 2002 to 5 years,
  from 8.5 years, after granting options with
  shorter vesting periods. That change cut option
  costs by 29.3 million.

99

• Jack T. Ciesielski, publisher of the The
  Analyst's Accounting Observer, found that one out
  of five companies in the Standard Poor's
  500-stock index reduced option life, stock
  volatility, or both, in 2002, increasing actual
  or pro forma earnings in the process

100

• Derek Johnston-Wilson, an assistant accounting
  professor at Colorado State University, compared
  accounting assumptions used to value options in
  2002 with actual historical trends and found that
  many companies underestimated both volatility and
  the risk-free interest rate.

101

• Still others believe that lost in the debate
  about expensing is that, on the whole, it appears
  broad-based stock option plans may have been good
  for investors and employees alike. These
  opponents of expensing claim that options provide
  powerful incentives for companies to recruit and
  retain talented employees, especially during
  crucial startup periods, that they increase
  productivity by encouraging employees to act like
  owners, and that they drive innovation and help
  spread economic well-being. In short, they
  believe that stock options are the reason the
  United States has lead the worldwide technology
  revolution.

102

• Some have gone so far as to claim that mandatory
  expensing will put U.S. accounting policy on a
  collision course with innovation,
  entrepreneurship, competition, and new business
  growth. They believe that the next Cisco or Intel
  won't happen without stock options.

103
Politics and Stock Options

• The last time the FASB tried to require that
  options be expensed, Congressional pressure,
  combined with a lack of support from the SEC,
  caused them to back down. The pro forma impact
  of expensing was required disclosure in the
  footnotes, but expensing of options was not
  required.

104

• Political pressure is still significant.
• Robert Herz, Chair of the FASB appeared before
  Congress It would send a clear and
  unmistakable signal that Congress is willing to
  intervene in the independent, objective, and open
  accounting standard-setting process based on
  factors other than the pursuit of sound and fair
  financial reporting.

105

• Democratic Senator Barbara Boxer said a
  bipartisan group of senators is mapping out a
  strategy to prevent the Financial Accounting
  Standards Board (FASB) from possibly forcing
  companies to treat stock options as expenses, a
  move that would diminish their use.

106

• When companies grant stock options, they are
  'giving people a piece of the dream', Ms Boxer
  said. 'We can't stand by and let accountants
  wearing green eye-shades decide who is going to
  get the American Dream,' the senator added.

107

• Ms Boxer said granting options is 'how our
  high-tech companies attract the best and the
  brightest' and if the FASB tries to clamp down on
  the practice, 'I won't stand by and see it taken
  away'

108

• House Rules Chairman David Dreier (R-CA) and Anna
  G. Eschoo (D-CA) are the sponsors of the
  Broad-Based Stock Option Plan Transparency Act of
  2003. This legislation would prohibit FASB from
  doing anything about the treatment of stock
  options while the SEC studies the issue for three
  years.

109

• Drier, according to the Congress Daily AM, claims
  that expensing stock options is a public policy
  issuenot an accounting issue, and therefore
  requires lawmakers to weigh-in on the matter. He
  believes that expensing stock options would be
  the death knell for employee stock option
  packages, that would also hobble the ability of
  startup companies to attract talent, and
  therefore would stifle innovation. This would
  hurt the risk-takers who are creating jobs and
  wealth in this country.

110

• John Chambers, CEO of CISCO, claims that a
  requirement to expense options would force more
  high-tech jobs overseas

111

• While the SEC backed down and did not support the
  FASB in the 1990s when they proposed expensing
  options, it appears that today the Board has the
  backing of the SEC.
• Former SEC Chairman William Donaldson has stated
  that Congress should not be in the business of
  making up accounting rules.

112

• In 2002, Senators Carl Levin (D-Michigan) and
  John McCain (R-Arizona) introduced legislation
  that would only allow companies to take a tax
  deduction for stock options if they also report
  the expense on their income statement.

113

• According to the WSJ (March 28, 2005) The SEC is
  expected to assure companies that they will have
  considerable leeway in measuring the value of
  employee stock options in financial reports.

114

• SEC guidance is expected to stress that the new
  FASB standard rejected a one-size-fits all
  approach to valuing options.
• Companies wont be deemed to be acting
  unreasonably just because they used different
  methods to value their employees options than
  other companies in similar situations, or just
  because they reached different conclusions.

115

• Still, the SEC is expected to stop short of
  granting companies formal safe harbor
  protection against future litigation over their
  method of reporting options-related expenses.

116

• The SEC is also expected to respond to criticisms
  that charge regulators have failed to adequately
  study the reliability of measurement tools for
  valuing options.
• The issues companies will face in estimating
  options values are not unusual and indeed arise
  in other areas of accounting and finance.

117

• Companies have identified suitable methods for
  estimating future outcomes and obtaining reliable
  value estimates.