A heated debate about whether tech firms should account for stock options as an expense is resulting in a classic Silicon Valley response: a willingness to think differently.
A handful of technology companies are heading in alternative directions when it comes to giving employees incentives to stay and perform well. Software giant Siebel Systems, for example, has replaced stock options with stock grants and cash. Chip firm Nvidia also has turned to actual stock. And online retail giant Amazon has agreed to expense stock-based grants beginning next year.
More and more tech firms may be thinking outside the options box soon. Critics argue that stock options are not the only or the best way to provide a carrot to employees, and political momentum for options accounting reform is growing. This month, for example, the accounting standards agency proposed quarterly and annual disclosure of the cost of stock options beginning as early as December. If companies are going to take a hit in their financial reports for stock options, incentive plans that have always involved an accounting expense may look more attractive. "Companies (that) are expensing options will use less of them," says Dan Ryterband, managing director of executive compensation consulting firm Frederic W. Cook & Co. "The reason options were used with such abandon was that they were 'free."
A stock option gives a person the ability to buy a share of stock at a set, or "strike," price, typically the price of the stock on the day the option is granted. When given to employees, options usually "vest" -- become the property of the grantee -- gradually over a period of time spent at the company. Unlike actual stock grants or other equity giveaways, stock options do not have to be accounted for as expenses in a firm's profit and loss sheet. A company can instead tuck discussion of how options would have affected the balance sheet into a footnote in its annual report.
Because options are effectively "free," they have been particularly attractive to cash-poor start-ups. They also tie into technology firms' ethos of employee ownership. In addition, a variety of corporations have given large option grants to executives as a tool to "align" managers with shareholder interests.
Finance experts have argued back and forth for decades about whether to treat options as an expense on company balance sheets. But that relatively quiet debate has became a public firestorm over the past year in the wake of accounting scandals at firms such as Enron, WorldCom and Global Crossing. Critics have accused options of promoting deceitfulness and greed.
More broadly, the push for cleaner corporate books has included a call for expensing stock options. Wharton accounting professor David Larcker thinks such a requirement is long overdue. He was part of a task force in the 1990s looking into the issue for the Financial Accounting Standards Board, which sets guidelines for how companies report their financial results. His opinion on how to treat stock option grants didn't carry the day, but he hasn't budged. "It's clearly an asset transfer. It's clearly an expense," he says. "You're giving away value from the company to the employee."