IN APRIL, VICOM SYSTEMS INC. extended its stock option plan to include about half of its 75 employees. The company never dreamed that a change in accounting rules might make it regret the move.
But like many other small companies, Vicom may face a tough choice this fall: it can continue to issue stock options and take a painful hit on its earnings -- or it can cut back on options and find it harder to recruit the best employees, who are often lured by the prospect of getting a piece of the action. "Now we have to start looking at different types of incentives," says Connie Osborne, chief financial officer of the maker of image-enhancing computers. "Or we simply may not be able to attract or retain the executives we want."
The Financial Accounting Standards Board (FASB) is expected this year to propose that the value of stock options be charged against earnings. The only major effect of options now is to dilute existing shares. The group, whose rulings are usually adopted by the Securities and Exchange Commission, argues that options have value and should be treated like other long-term compensation. The board is trying to devise a formula that would help guide investment bankers to measure the stock's value. The complicated method would probably use market price, exercise price, and any dividends to calculate a charge that would be spread over the option's vesting period. "Financial statements ought to reflect all the economic activities at a firm," says David Boehm, an FASB project manager.
Critics claim it's nearly impossible to measure the future value of a fledgling company's stock. If the rule is adopted, it could take the burnish off the bottom line of many small companies. The National Venture Capital Association estimates that most start-up companies would suffer a 20% to 40% drop in pretax earnings. Robert McAdams, chief financial officer of Measurex Corp., a computer manufacturer, says that the accounting changes would cut company earnings by at least 10%, or $2 million. Such steep drops could scare away some investors. "It will make small companies less competitive in the marketplace for money," says Donald Campbell, a partner in Hambrecht & Quist Leasing Partners.
Small companies, eager to put on the best financial face for investors and creditors, may have to try other incentives. Vicom, for instance, is considering such potentially cheaper lures as providing financial planning or simply boosting salaries.