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Expensing of Stock Options

Updated: October 1, 2003


Issue:

Proposals are being considered by both the Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB) to mandate the expensing of employee stock options.

Technology entrepreneurs use stock options to attract and retain their employees. A survey conducted by the Council of its membership indicated that approximately eighty percent of the responding companies grant stock options to more than eighty per cent of their employees.

Governmental Activity:

In response to FASB's and IASB's proposals to mandate the expensing of employee stock options, legislation has been filed in both Houses of Congress that would:
  • Direct the Securities and Exchange Commission to promulgate new rules requiring enhanced disclosures of the effects of stock options on a shareholder’s interest in a company. Such new disclosures would require plain English descriptions of the dilutive effect of option grants, prominent display of pertinent information regarding stock option plans and a summary of the options granted to the 5 most senior executives.
  • Require that the SEC, after three years from the issuance of the new disclosure rules, conduct a study of the effectiveness of the enhanced disclosures in increasing transparency to current and potential investors and to deliver the results of the study to the appropriate congressional committees within 180 days and prohibit the SEC from enforcing any new options accounting rules for 60-days after the study is transmitted.
  • Require that the Commerce Department, within one year after enactment of the legislation, submit a report to Congress on the effects stock options have on matters such as recruitment and retention of skilled workers, stimulating research and innovation, economic growth of the United States and strengthening the international competitiveness of US companies
Software Council Position:

The Council favors full and frequent disclosure to investors of the dilutive effects of stock options on earnings per share.

The Council opposes regulations or legislation that would force companies to expense the granting of stock options. The expensing of stock options would severely damage the ability of technology entrepreneurs to build and retain their workforce through granting stock options to their employees and would likely end the use of stock options except for the most senior executives.

The real cost of employee stock options lies in the potential dilution of each investor’s share of company ownership. Requiring that employee stock options be counted as a compensation expense would result in double counting in the earnings per share calculation, which would provide misleading information to investors.

Even assuming that employee stock options are an expense, there are presently no pricing models that adequately value them. The only model for valuing stock options that does not mislead investors is the “intrinsic value” method set forth in APB Opinion No. 25, where the difference between the fair market value at the time of the grant and the grant price is expensed.

Most important, the Council believes that the intrinsic value method of valuation is particularly appropriate for broad-based employee stock ownership plans. The Council urges FASB to redirect its efforts to reform Statement No.123 toward stimulating a discussion of the intrinsic value method as it relates to the promotion of broad-based plans.

Software Council Activity:

The Council has been an active member of the International Employee Stock Options Coalition, which consists of a wide range of trade associations and companies, including high-tech, manufacturing and service companies, in the U.S. and abroad that support broad-based employee stock option plans.

The Council has worked closely with the Massachusetts Congressional Delegation to urge their support of broad-based employee stock option plans and their opposition to legislation that would mandate expensing of stock options.

The Council established a Task Force on stock options, which focused its attention on methods of valuing options and filed comments with FASB endorsing the intrinsic value method of valuation.


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