FASB Issues Statement on Stock Options

FASB Issues Statement on Stock Options
Companies to Expense Compensation Packages

By Simon Eskow

Continued from the Home Page

“It’s good to see that FASB hasn’t backed down,” said George Victor, chairman of the New York State Society of CPAs’ SEC Practice Committee. “There’s always that risk that Congress can interfere, but (FASB Chairman) Robert Herz vowed he was going to go through with this, and he did.”

Lawmakers and businesspeople seemed drawn into opposing camps in the two-year saga of Statement 123. Some companies feared full reporting would have an inimical impact on their profitability, while their supporters in Congress, such as Rep. Richard Baker (R-La.), challenged FASB’s authority. Others, however, viewed reporting of share-based compensation as a logical extension of full transparency and responsibility to investors.

Baker’s bill, which would have limited the reporting requirement to a company’s five highest-paid executives, passed in the House last July by a 312-111 vote, where it was moved to the Senate Banking Committee, chaired by Sen. Richard Shelby (R-Ala.), who has voiced his support for FASB in the past. By autumn, a committee spokesman said that the Senate would not act on the bill this year, clearing the way for FASB to issue Statement 123 unopposed.

“Recognizing the cost of share-based payments in the financial statements improves the relevance, reliability, and comparability of that financial information,” Michael Crooch, a FASB board member, said in a statement. “(It) helps users of financial information to understand better the economic transactions affecting an enterprise and supports resource allocation decisions.”

Sudden Impact

FASB’s exposure draft, issued last March, incited prompt reaction, most notably from information technology companies and their employees. But the use of stock options stretches far beyond that sector.

“This is going to have an across-the-board impact,” Victor said. “What you’ll probably see is…a significant impact on corporations’ view of compensation packages. I think in some cases you’ll see a decline in its use, because in many cases it has a big impact on the profitability of the company, and companies will be hesitant to have a stock option plan.”

The transition from handling stock options as a footnote in financial statements to including them as an expense can have a “material impact,” said Stamos Nicholas, a principal with Deloitte & Touche’s Valuation Services Practice.

“Clearly, transparency is the major aspect of this statement,” Nicholas said. “Investors will see a number that will be expensed, based on key assumptions. The methods and assumptions must be reasonable to make people comfortable.”

The statement provides some latitude in valuation methods, so that companies can employ such methods as the Black-Scholes formula or the lattice model for pricing stock options.

Nicholas said that aside from the impact on profitability, there may be some cost to companies in conforming with Statement 123, especially in developing the right methodology for valuation. Accounting firms working with stock issuers will also have to become more comfortable with those methodologies, he said.

No matter what the method, the expense is going to add pressure from “outside investors” because of the effect it will have on profits over loss, Victor said.

And opponents to the rule said that even using widely accepted valuation models is risky because it forces companies to make assumptions about stock value.

“The new stock option…standard…will not result in better corporate financial reporting but will create new risks and problems” for technology sector companies, said George Salise, president of the Semiconductor Industry Association, in a press release. “The rule requires companies that grant employee stock options to make many subjective assumptions about the value of options, which in turn could affect the share price of their stock.”