Barring surprises, back to international taxation, particularly expatriate US corporations, tomorrow.
Today, I want to write about the financial accounting when a corporation pays an executive with stock options. This is not a new topic, and I have nothing new to add to the debate, but it is important, and the issue is hot again, as to be discussed below.
Under current financial accounting rules, when a company pays an executive with a stock option, the company is not required to show any expense (cost), ever. The executive may exercise the option and get millions of dollars worth of stock for nothing (that she then may sell for even more) and the corporation's books say that the executive got nothing. All of the other shareholders got their percentage ownership of the company diluted, with an associated loss in value of their shares. A portion of the company's assets has been transferred to the executive. The company gets an income tax deduction. But financial accounting says that the executive's compensation cost the company nothing.
Business, particularly high-tech business, views the current accounting as a deity: There is no real cost, they say. Proper accounting would discourage innovation. Bad statements help US companies compete with their honest offshore rivals. It is hard to value stock-based compensation. Shameless nonsense! There are difficult timing and measurement issues involved, but these concerns are no excuse for never showing any cost.
The Financial Accounting Standards Board (FASB), the glorified trade association that the SEC lets sort of police accounting principles, considered changing these rules in the early 1990s. Senator Lieberman pushed through a Sense of the Senate Resolution that FASB's authority would be rescinded if they did anything about stock options. FASB caved.
Many blamed the recent corporate scandals, like Enron, in part on stock option accounting: The accounting rules encouraged companies to pay executives with stock options. But, when most of an executive's compensation is stock-based, that gives the executive an unhealthy incentive to focus on manipulating the price of the stock rather than managing the company's business.
In February, FASB's European competitor, the International Accounting Standards Board, required accounting for compensatory stock options. With this cover, in March, FASB again proposed more reasonable accounting rules here. And, this time, the House last month passed a bill that would reverse FASB. Hopefully, the Senate will resist the opportunity to once again put its imprimatur on misleading financial statements, but……