The Importance of Expensing Stock Options in Corporations

“Brokers may seem like clever financial experts, but they are first and foremost salespeople” (Levitt, 17).

Every time we look at the economic and finance pages of a newspaper our eyes focus on the diversity of charts trying to visualize the fluctuations among the stock diversity. Those lines that move up and down turn into our guideline for evaluation of the possible trends a stock price may take. Unfortunately, no everyone thinking about investing in stocks have the necessary knowledge to be successful.

Investing in stocks involve more than just looking at those lines in a newspaper because those lines do not reveal what is going to happen in the future to the value of stock prices. Instead, those lines are a storytelling of what has happened with a determined stock during the past. Due to this reason, it requires knowledge and expertise in accounting, finance, and economics to make a successful and profitable stock investment. As an alternative, investors rely heavily on the expertise of economic advisors, brokers, and all sorts of stock gurus to guide them through the investment process.

A corporation seeking financial aid relies heavily on the expectation investors have on its future value, because if they believe they could make a profitable return by buying stock, investments will be made.

Investors are the most valuable aid companies have, because investors provide the money capital for present and future economic development of companies. So, there is a strong relationship tied between investors and economical advisors.

Investors need economic advice from stock savvies and economic advisors rely on the money capital from investors to make profit in their businesses. However, the lack of knowledge and blind trust investors had given to stock brokers and other gurus is being understood as a disadvantage. How can lack of knowledge be a disadvantage if investors are paying advisors and brokers to manage their investments? The reason is far deeper than just a conflict of interest. Arthur Levitt explains far in detail, “Wall Street firms viewed analysts as marketing tools” (Levitt, 69) and “Brokers may seem like clever financial experts, but they are first and foremost salespeople” (Levitt, 17). Thus, there are two knots in this imaginary rope of transactions. The first knot being the relationship between investors and financial advisors, and the second one is the relationship brokers and economic advisors have with corporations.

Since disequilibrium governs in the future return investors should have, government agencies strive constantly for the creation of a fair market and better rules applying to the ways stocks should be managed. In recent years, a trend of unmoral accounting practices and corporate behavior has melted several corporations. As Levitt points in one particular corporation,

"Enron used accounting tricks to remove debt from the books, hide troublesome assets, and pump up earnings. Instead of revealing the true nature of the risk it had taken on, Enron’s financial statements were absurdly opaque. Auditors went along with the fiction, blessing the off-the-books entities that brought the company down. Most analysts also played along, recommending Enron’s stock even though they couldn’t decipher the numbers. Analysts were foils for their firms’ investment banking divisions, which had been seduced by the huge fees Enron was paying them to sell its debt and equity offerings.” (Levitt, 14)

We realize investors are naked on a frozen street were rules are made to bring warm only to those who have a deep understanding of the stock rules and interests. Since misinformation is a worrisome and daunting issue, companies could indeed take advantage of it by creating bias for investors to make unprofitable investments to satisfy the greed of few.

In an effort to avoid further manipulation of stock prices, the Financial Accounting Standards Board (FASB) failed to accomplish ruling on stock options to be accounted as an expense in the Income Statement of corporations. Levitt explains the reason,

“The rule would have crimpled earnings and hurt the share price of many companies, but it also would have revealed the true cost of stock options to unsuspecting investors.” “Fearful of an overwhelming override of the proposal, I advised the FASB to back down.” (Levitt, 10-11)

Another reason for expensing stock options is the misuse of stock for tax avoidance. Companies have learned that it is possible to cut wages taxation by paying part of employee’s salaries in stock. The FASB explains in detail this mechanism,

“The conceptual roots of the drive to expense employee stock options can be found in the view that, by issuing stock options, companies are able to avoid the cash expense associated with other methods of employee compensation. Thus, a company that might have to pay $500,000 in salary to attract an executive might be able to acquire his or her services for half that amount with an offer of stock options. From the employee’s point of view the trade might be worth the difference in cash compensation because she believes that the company has good prospects for substantial share growth. The employee may also believe that it can enhance the likelihood or extent of that growth. In this example, the company has saved a hypothetical $250,000 by issuing stock options that do not appear--as would cash salary--as an expense on its income statement. The income statement, it is argued, thus understates the company’s costs in producing its income and overstates the company’s real earnings.” (Hassett, 3) 

If a corporation must expense stock options, how would they assign value to the expenses incurred in issuing stock? The answer would be the difference between the stock price initially issued minus the market price—final price at which an investor acquires stock—If this differ a value, then to account this expense in the balance sheet an account called “common stock option outstanding” (Cooke, 154) will be required. A numerical illustration is necessary to visualize the effect in the Balance Sheet of the Financial Statements of corporations. In the book Finance for Non-Financial Managers, Robert A. Cooke, exemplified,

"Common stock options outstanding $200,000Less: Deferred compensation on stock options $160,000Net common stock options outstanding $ 40,000Or, you might see a financial statement with one line in the equity section of the balance sheet that reads, “Stock option transactions, net” followed by the net figure (as the $40,000 above) There would also be some addition to compensate expense." (Cooke, 154)

If stock options being calculated as an expense seems to benefit investors and corporations in the long-run, why not enforcing it? It seems the debate about this proposal will continue on due to the millions of dollars involved in daily transactions benefiting everybody but investors—at least fairly like it should be.

Even though the US Securities and Exchange Commission (SEC) is being extra careful and the FASB keeps pushing for newer reforms, it is important to accomplish this goal of expensing stock options for the creation of fairer and better stock markets that we hope future generations will enjoy and pursuit for economic happiness.

Works Cited

Hassett, Kevin. “The FASB Stock Options Proposal. Its Effect on the U.S. Economy and Jobs.” 21 April 2004

Levitt, Arthur and Paula Dwyer. Take on the Street: what Wall Street and corporate America don’t want you to know; what you can do to fight back. New York: Pantheon Books, 2002.

Cooke, A. Robert. Finance for Non-Financial Managers. 2nd ed. New York: McGraw-Hill, 2004.