Option Plans Under Threat
Accountants around the world are struggling with an issue that could end up discouraging a lot of companies from offering stock options to staff.
The issue is whether options should be included in company accounts and, if so, what value should be put on them. And it’s coming to a head right now because a bunch of accounting standards bodies -- from Australia, Canada, New Zealand, the U.K., and the U.S. -- are chewing over proposals for common rules governing the matter.
The proposed rules are based on the view that stock options are just another form of staff compensation and thus should be included in profit-and-loss statements. Not including them, as is currently the case, misleads investors, the argument goes.
The most contentious issue concerns the way in which options might be valued. The various accounting standards bodies, together with the International Accounting Standards Committee -- known collectively as the G4+1 group -- are considering a formula for calculating the value of options that could prove a big headache for startups. The key point is that it gives the value on the vesting date, the time when all the conditions for being able to exercise the options have been met.
This differs markedly from voluntary rules for including options in accounts that have already been adopted by the U.S. Financial Accounting Standards Board (FASB). These say that the value of options should be taken at the time they are granted - and that's likely to result in a much lower value than one taken at the vesting date.
In any case, the voluntary rules in the U.S. are hardly ever used in practice. When the FASB tried to make them mandatory five years ago, they ran into very heavy weather. Companies like Cisco Systems Inc. (Nasdaq: CSCO) and Intel Corp. (Nasdaq: INTC) campaigned bitterly against the proposals and forced the FASB to back down.
The issue is back on agenda, thanks to the U.K.’s Accounting Standards Board (ASB), which is trying to grab the initiative in formulating international accounting standards. The European Commission has set a deadline of 2005 for establishing common standards in the European Union, and the ASB is trying to kill two birds with one stone by establishing international rules at the same time.
This effort is being led by Sir David Tweedie, the ASB’s chairman, who is scheduled to take over the chair of the International Accounting Standards Committee on January 1, 2001. It's Tweedie and the ASB that's putting forward the idea of valuing options at their vesting date.
Fortunately, some would say, these accounting standards bodies move pretty slowly. The IASC will take until at least mid 2001 to come up with its own proposed rules covering options, according to Kimberley Crook, a project director at the ASB. Then it’ll have to collect comments and revise the standard, which will take until some time in 2002.
All the same, the threat of having to account for options is already worrying some U.K. startups, according to Julia Bracewell, a partner at Brobeck Hale & Dorr International, a law firm specializing in hitech ventures. If options were counted as part of employee compensation, then companies would have to stump up much bigger social security payments -- and that’s something that startups need to plan for in advance, says Bracewell. "Right now, they're between a rock and a hard place," she adds. They can't tell how much option plans might cost them in the future.
This issue has already been dealt with in the U.S., where the idea of having to pay bigger social security payments or income tax on options has already been ruled out.
The prospect of the ASB introducing its proposals ahead of other countries -- which the ASB has hinted at -- has caused widespread consternation in the U.K.
It would put U.K. companies at a huge disadvantage, according to Diane Hay, chief executive of ProShare, a not-for-profit organization that promotes private and employee share ownership in the U.K. “If you became successful, it would hit your profit and loss account,” she says. “It’ll put companies into a position where they'll become insolvent. They won’t be able to buy anybody, and nobody will want to buy them.”
”The employer would have an open-ended liability for the options it's granted," warns Stephen Harris, a director of Jeffrey & Co, a U.K. firm of accountants. "As the underlying share price goes up, the deemed value of the options would go up, and that means that the government's take would also go up."
In the U.S., the FASB makes no secret of the fact that it would like to adopt the rules being formulated by the IASC -- and make them mandatory this time.
“In general these kinds of accounting proposals force management to acknowledge that there are costs to giving out options,” says Doug Reynolds, a practice fellow at the FASB. “It’s important for investors to know when more shares are being given out, because that can dilute their interests. We feel that shareholders can make better decisions when they are given more information.”
This view is challenged by Armondo Castro, legal counsel for Cyras Systems Inc. a U.S.-based startup “These options don’t really reflect an actual cost to the company in terms of cash spent,” he says. “Yes, options do affect equity of all shareholders, but that’s already accounted for when companies report how many shares are still outstanding.”
Five years ago the arguments against introducing mandatory accounting rules for options weren’t so subtle. “Congress was getting pressure from businesses saying that the new rules would ruin the economy,” says Carrie Bloomer, project manager at FASB. “FASB’s whole existence was put on the line, and we felt we wouldn’t be able to fulfill our mission of improving financial reporting if we were put out of business.”
The ASB's Crook reckons the FASB will come under pressure to adopt the IASC rules for including options in accounts once other countries, such as the UK, take a lead. However, the FASB is still licking its wounds from its previous brush with America's hitech industry and seems in no mood for another fight. “We have already dealt with the issue,” says Bloomer. “It’s not likely it will be on the agenda again anytime soon.”
-- Peter Heywood, international editor, and Marguerite Reardon, senior editor, Light Reading, http://www.lightreading.com