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Accounting options: A new tech order

Technology companies fighting against changes in how stock options are expensed are battling the Federal Reserve Board, the U.S. Congress, investors and, now, each other.

6 min read
Technology companies fighting against changes in how stock options are expensed are battling the powerful chairman of the Federal Reserve Board, many members of Congress, investor sentiment and, now, each other.

Recent decisions by Amazon.com and Computer Associates International to begin expensing employee stock options have broken the tech industry's unified front and cast some doubt on a key argument for retaining the accounting status quo--that employee option programs will be gutted.

Calls for changing the way corporate America accounts for options-related expenses have been rekindled by accounting scandals roiling the energy and telecommunications industries. Proponents of requiring companies to list stock option as expenses say that investors need more clarity in determining the financial health of a company.

Opponents--principally the tech industry, where options have been liberally distributed--have countered that any change would cost tens of millions of dollars and result in companies removing rank-and-file workers from the programs.

The high-tech lobbying firm TechNet, whose members include Microsoft, Intel, Cisco Systems and Hewlett-Packard, has issued particularly dire predictions.

An accounting change "could have devastating consequences and impede our ability to compete at a high level as a country," said TechNet Executive Vice President Connie Correll. "If you don't offer people a piece of the action, it's going to be hard to get employees to dive into a company and innovate and stay a cut above industry competitors in China, Japan and elsewhere in the world."

So have Amazon and CA just sealed their own fates?

Last week, online retailer Amazon said it will begin expensing options next year. CA on Monday also voluntarily agreed to do the same. However, neither company said the change would force any drastic changes to the way they hand out options.

Amazon Chief Executive Jeff Bezos emphasized that the company's program will continue--even though last year the change would have caused Amazon's $567 million loss to balloon to $963 million.

"Employee ownership was one of the founding tenets of Amazon.com," Bezos said. "That commitment won't change."

Some insist that Amazon's commitment to continue offering a broad-based employee stock-option program while expensing the cost is an exception, not the rule.

We got to where we are by not only having great products and service but by having aggressive compensation.
--Michael Gallant, spokesman, EMC
"You can't make broad conclusions from what Amazon did," said Kim Boylan, a lawyer in Washington, D.C., who helps organize the International Employee Stock Option Coalition. That group of companies and business associations opposes changes to accounting treatment of stock-option programs. Members include TechNet and Semiconductor Equipment and Materials International.

"We do still believe that most technology companies with broad-based plans feel if they are forced to expense options, it will cause them to change their plans and will be more harmful to rank-and-file employees," added Boylan. "Our sense is that it would have a negative impact on broad-based option plans."

In a statement, CA's chief executive, Sanjay Kumar, was slightly less definitive than Amazon about the future of his company's program: "The new policy puts options on an equal footing with other kinds of compensation and will allow us to continue to design compensation packages that motivate employees and align their interests with those of all share owners."

TechNet representatives said Monday they did not have anyone available to comment on the Amazon or CA announcement.

Standing fast
Additionally, representatives of software maker Ariba and online travel store Expedia said they wouldn't change their use of options, regardless of what accounting rules were in place. An eBay representative said that while the company doesn't know how its use of options would be affected, options continue to be important for the company.

Storage maker EMC, which isn't officially expensing options but started spelling them out to investors in its most recent quarterly earnings report, said it plans to continue its options program. Had it expensed options in the most recent quarter, its $808,000 profit would have been a $91.2 million loss, the company said.

"Options are a key component in a highly competitive market," EMC spokesman Michael Gallant said. "We are a market leader. We got to where we are by not only having great products and service but by having aggressive compensation."

Representatives from Oracle, Siebel Systems, Yahoo and Cisco declined to comment on what impact a change in accounting would have on their options programs.

Whatever the impact on employee option programs, expensing them would have a dramatic impact on the tech industry's profitability.

Companies must disclose their stock-option expenses in their annual reports as a footnote. Based on this information, a recent Bear Stearns report estimated that such a change would result in a drop of about 20 percent in the earnings per share for companies in the S&P 500.

Currently, the options expense is reported to the Internal Revenue Service, and companies can write it off as a business expense and receive a tax benefit. Companies also receive a cash infusion when employees sell their stock, receiving the amount of money up to the stock's strike price.

Over the last three years, for example, Siebel has received a $331 million stock-option tax benefit in addition to getting an additional $422 million through employees selling stock, according to SEC filings. Last year, if Siebel had expensed options, its 2001 profit of $254.6 million would have dropped to a loss of $467.2 loss.

At Intel, the change would have shrunk a $1.3 billion profit in 2001 to just $254 million.

"(Expensing options) would cause us to re-evaluate the (stock options) program we have now," said Intel spokesman Chuck Mulloy. "It may cause us to change (the program) because of the adverse affect on profitability. We would have to evaluate if a broad-based program for all employees would be possible."

Nevertheless, change could be forced upon the industry from several points.

There's pressure from such economic heavyweights as Federal Reserve Chairman Alan Greenspan and investor Warren Buffett. The U.S. Senate also tried and failed to change the accounting rules earlier this month, but more legislation may be proposed.

Greenspan has predicted that the Financial Accounting Standards Board (FASB), which sets accounting rules in the United States, would soon adopt the change. Meanwhile, a board that will eventually set accounting rules for the European Union has already taken a step toward requiring the accounting change, which could put pressure to FASB to adopt a similar position.

Peer pressure may become a factor as well. In addition to Amazon and CA, companies such as the Washington Post and Coca-Cola have made the switch.

Win-win deal?
The widespread use of stock options in the technology industry has largely been seen as a win-win scenario, since it helps companies attract and retain employees and gives workers the chance to profit far beyond their paychecks.

But in this stubborn down market, some people argue that expenses have lost some of their luster for both employers and workers.

Although options paid off big for some workers, others have had plenty of dark stories about owing taxes on nonexistent profits and about vast amounts of stock being "under water" or worthless at the current stock price. Some companies have tried to compensate by repricing options or issuing new grants at lower prices. But many of those options have quickly gone under water as well.

"We're now seeing the flip side of options," said John Challenger, chief executive of Chicago-based employment company Challenger, Gray and Christmas.

"They now feel like a lottery ticket. And lottery tickets are worthless."

News.com's Alorie Gilbert contributed to this report.