Stock Options Back On US Legislative Agenda

by Mike Godfrey, Tax-News, Washington

12 July 2002

One of the legislative reactions to perceived US corporate excesses has been to reduce the attractions of stock options, specifically by obliging corporations to deduct the cost of stock options from their reported earnings; but until recently there has been relatively little enthusiasm for such a measure in either Congress or the administration.

This is odd, really, because it seems a no-brainer to conclude that the ability to convert generous stock options into cash during the recent bull market will have influenced executives to record the highest possible profits, and that if options can be issued 'cost free' in terms of earnings per share then the temptation to inflate profits unjustifiably will become irresistible for all but the most morally robust executives.

From a shareholder's point of view, deducting the cost of stock options recognises a true business expense, thus serving the current God of transparency. That the logic behind stock option deductibility should be ignored, despite its long-term beneficial consequences for shareholders, owes something to short-termism, but perhaps just as much to an effective lobbying campaign by the high-tech industry, which was an important donor to both parties during the high-tech boom.

Federal Reserve Chairman Alan Greenspan agrees that companies' ability to pay employees through options grants without deducting them as an expense overstates their profits and results in inefficient allocation of capital to wasteful projects, hurting economic growth.

It seems even more strange that companies are allowed to deduct the cost of stock options for tax purposes, while not counting them as an expense in financial statements; it is altogether too easy to believe that the resulting distortion has a lot to do with the 'irrational exuberance' that has now so horribly come home to roost.

Still, Congress has not seen fit to legislate. A bill introduced earlier this year by Senators Carl Levin (D, Mich) and John McCain (R, Ariz) to require any company that treated options as an expense for tax purposes to do the same in its financial statements has languished. Levin and McCain say they are still considering whether to introduce their bill as an amendment to Banking Committee Chairman Paul Sarbanes's fashionable accounting bill.

That may not happen for procedural reasons; but if nothing else the recent escalation in corporate debacles has put stock option expensing firmly back on the agenda.

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