BACK IN 1993 the regulators who set accounting standards advanced a straightforward idea: Companies that pay workers with stock options should report their cost, just as they report the cost of salaries and other forms of compensation. It was hard to object to this notion; company reports are supposed to tell investors how profitable the companies are, and leaving out a large expense undermines that purpose. High-tech companies lobbied Congress against this form of honest accounting, and the regulators retreated. Now, in the wake of Enron and other scandals, the regulators are trying again to do the right thing, on the general theory that capitalism works best when investors have access to as much clear and accurate information about companies as possible. But a bill that again would gut the proposed reform has attracted more than 100 co-sponsors in the House and looks set to pass in the Financial Services Committee.
The first problem with the House bill is that accounting standards, like interest rates or determinations on drug safety, should not be set by Congress. They should be determined by the Financial Accounting Standards Board, which, unlike the House of Representatives, is filled with accounting experts who listen to corporate views but do not depend on corporations for campaign contributions. The FASB cannot be effective if it is second-guessed by lawmakers and lobbies. In 2002 no less a figure than Rep. Michael G. Oxley (R-Ohio) wrote that "the FASB's independence from Congress . . . is fundamental to achieving its mission." Mr. Oxley is chairman of the House committee that now threatens the FASB's independence.
The second problem with the bill is its illogical content. In the past, opponents of expensing options have claimed that the value of options is unknowable. But the House bill abandons that claim by requiring that companies include in their profit-and-loss statements the value of options for their top five executives. Having conceded that, however, the bill goes on to say that the cost of options granted to employees outside the top circle should be left out, implying that they cost nothing. But they do not cost nothing. In high-tech companies, which grant options generously to middle-ranking employees, the top five executives get only a small fraction of the total -- less than 5 percent in the case of Intel Corp. or Cisco Systems Inc.
Moreover, the House bill stipulates that companies should use an unorthodox method for valuing options that minimizes their worth. If the bill became law, the options granted by Intel last year would force it to deduct a modest $3.5 million from its reported profit -- compared with the hefty $991 million it would have to deduct under the proposed FASB reform. Cisco, for its part, could report $1.1 billion more in profit if the House bill passed. Small wonder that Intel and Cisco have led the lobbying charge in favor of the legislation.
Rep. Richard H. Baker (R-La.), the author of the House bill, offers an explanation for the idea that only the options going to the top five executives should be expensed. It's that options create a special hazard when granted to bosses with the power to manipulate their value by distorting a company's quarterly results; shareholders have a particular need to understand the incentives available to top executives, according to this argument. But those incentives are already disclosed in a firm's proxy statement to shareholders, and the case for expensing options is different. The cost of options should be reported for the simple reason that they are indeed a cost. Congress should not pretend otherwise.