Revista de Contabilidad-Spanish Accounting Review
5 stars based on
In the post-Enron era it has become very popular to propose the requirement that companies record an expense at the time a stock option is awarded. FASB indicated that performance-vested stock options and earnings management level playing field did not exist in the reporting of management incentive compensation.
Companies that rewarded management with cash bonuses were required to report a compensation expense for the amount of the bonus paid, thereby reducing net income. In contrast, FASB stated, companies that rewarded management with stock options did not have a comparable reduction in net income. The method of calculation was not to be mandated.
This Model was developed in and consists of a set of algebraic equations. It has been used by many option traders. In essence, FASB was saying that, if the company sold the option in the public market, it would receive a cash payment from the buyer.
By giving the option to the employee, the company was foregoing the cash it would receive if it sold the option. Subsequent to the floating of the draft proposal by FASB inmany hi-tech companies voiced strong objection.
These companies argued that employee stock options were the primary incentive they had to recruit technology professionals and to motivate various levels of employees. The opposition by technology companies did not immediately influence FASB, and the development of a proposed standard requiring expensing continued.
At performance-vested stock options and earnings management point hi-tech companies began contacting their Congressional representatives. When FASB failed to bend, members of Congress took an extremely aggressive posture on this matter — to the point that the existence of FASB as an independent standard setter was threatened.
In repose to this threat, FASB Statement was revised to require only footnote disclosure of the pro forma effect on net income and earnings per share if an expense had been recorded. The concept of a level playing field has been supplemented with a new rationale for recording the expense. This rationale starts with the premise that companies such as Enron, Global Crossing, and WorldCom used accounting treatments that were improper and unethical in order to inflate net income and earnings per share.
These company executives were motivated to increase the stock price because it would be financially rewarding to the management since they held substantial options on the stock. If the companies had been required to record an expense at the time the option was granted, they would not have been so generous with the options. Performance-vested stock options and earnings management curtailing the performance-vested stock options and earnings management, the incentive to inflate net income and earning per share would have been reduced.
Several arguments have been made, both pro and con, regarding this issue. Following is a summary of the key arguments on both sides. At the time the option is exercised, the employee must pay for the shares received. As to the improved corporate governance argument for the change, the Securities and Exchange Commission certainly has just cause to seek improvements in corporate governance.
However, there are ways of accomplishing this without creating controversial accounting requirements and penalizing employees below the top level of management. There are more effective ways to accomplish this than the FASB proposal on expensing options.
For additional views on the subject of expensing stock options, please refer to the following Wall Street Journal articles:. Web services will enable organizations to integrate their information, applications, workflows, and customer transactions in more versatile web environments. No longer does one plus one always equal two — in a given reporting period anyway. Living in a complex performance-vested stock options and earnings management and moving into the smart machine age, the need for good leadership is even greater; spiritual leadership provides a compass to navigate through difficult decisions.
A review of the interaction of finance and religion shows not only has there been a long historical relationship between them, but religion continues to influence financial decision-making. Bartley, July 29, There are two issues surrounding the recording of an expense when an option is awarded: Does the expensing provide a level playing field in accounting for management compensation? Would the recording of an performance-vested stock options and earnings management when an option is awarded improve corporate governance?
Pros Expensing options will provide a level playing field so that companies that use cash bonuses and companies that use stock options each have an expense on the income statement. It will improve corporate governance by reducing or eliminating incentives to inflate income and earnings per share. Cons The playing field is already level. A company using cash bonuses as management incentive performance-vested stock options and earnings management has a reduction in net income and a resultant reduction in earnings per share.
When a stock option has been awarded and the strike price is in the money, the additional shares become outstanding for purposes of calculating earnings per share. Since earnings per share is calculated by dividing net income by weighted average shares outstanding, as the shares outstanding increase, the earnings per share decrease. To require a company to record an expense for the option, and subsequently increase the shares outstanding is a double hit to earnings per share.
Regarding improved corporate governance, it is difficult to believe that the management or the Board of Directors of Enron would have limited the number of options simply because of the requirement to record an expense. Such is the nature of recording an expense when an option is awarded. This is an accounting entry with no cash impact. This would likely lead to companies including a pro forma income statement which excluded the option expense. Hi-tech companies have traditionally issued options to multiple levels of employees with two purposes in mind: If hi-tech companies were required to record an expense at the time options are granted, many employees at all levels would most likely lose the options.
Two suggested methods of dealing with options that could improve corporate governance are: This stock performance-vested stock options and earnings management be held for two years before it can be sold.
For additional views on the subject of expensing stock options, please refer to the following Wall Street Journal articles: More articles from Volume 5 Issue 4.
Gregory, JD and Stephen J. Phillips, PhD and Sonja A. Web Services May Bridge the Great Culture Gap Web services will enable organizations to integrate their information, applications, workflows, and customer transactions in more versatile web environments. Spiritual Leadership Living in a complex world and moving into the smart machine age, the need for good leadership is even greater; spiritual leadership provides a compass to navigate through difficult decisions.
How Religious Beliefs Influence Financial Decision-Making A review of the interaction of finance and religion shows not only has there been a long historical relationship between them, but religion continues to influence financial decision-making.