Management Toolkit

Why options matter

J. William Gurley CNET News.com

Published: 27 Aug 2003 16:35 BST

Although it has been more than three years since the now infamous economic bubble burst, regulators, congressmen and the media remain remarkably insistent in identifying a blame agent for the excesses of the late 1990s.

Economic bubbles exist precisely because everyone is caught up in the game: the US Securities and Exchange Commission approved every S-1 filed in the late 1990s; congressmen welcomed the tax income from excessive capital gains (and even planned for it indefinitely); and the press, as you know, hailed Enron's rise as much as it publicised its demise.

The latest target of this well-intentioned group is stock options. It seems that stock option instruments -- as opposed to human greed, malfeasance and corruption -- were so dangerously alluring that they encouraged otherwise ethical men and women to commit fraud on our economic system. It seems that options offer way too much upside for executives without the appropriate downside exposure, encouraging them to take unnatural risks as leaders of corporate America.

The first strike in the war against stock options is insisting that they be expensed on a company's income statement. The argument is that options represent a grant of value from a corporation to its employee and therefore should be expensed on a generally accepted accounting principles (GAAP) basis. While companies are not currently required to expense options, they are required to disclose the exact nature of all option grants in their financial statements. Many believe that the Financial Accounting Standards Board (FASB) will require the expensing of stock options in the future.

The second strike against options came on 8 July, when Microsoft announced that it would forgo all future stock option grants in favour of restricted stock grants. Business Week heralded "Microsoft's bold new pay plan," and many others speculated that this single action represented the beginning of the end of stock options. Newsweek even jumped in on the action, declaring that "options have lost a lot of their allure."

Despite these reactions, many questions lack succinct answers. Should stock options be expensed? What about restricted stock? Is restricted stock better for employees? Is restricted stock better for shareholders?