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Posted 2/10/2003
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Stock options: Boon or simply boondoggle?
Corporate America thinks the granting of stock options entitles companies to deduct the value of exercised options from corporate taxes. But conveniently, companies dont claim options as an expense. Why should the corporations get both?
By Bill Fleckenstein
Let's hope that the chairman and vice chairman of the Nasdaq never moonlight as writers of history texts. In that scenario, readers would encounter "stock options" at the top of a list of great contributions to modern civilization. Perhaps their greatest "contribution" lies in boosting corporate America's cash balances. No wonder, then, that efforts to reform stock-option abuse have been met with howls from high places.
Walked-on eggshells litter Barrons Roundtable
One of the things that I continue to be struck by is the lack of remorse or shame or chagrin -- much less a real change in behavior -- on the part of the bulls and former Bubbleonians. And I dont mean the public here. What I mean are the Wall Street strategists, the dead-fish community and corporate America at large. A few weeks ago, I remarked on the smugness of the Barrons Roundtable panelists who had been wrong in their prognostications from last year. Barrons did not take the occasion of its forum to hold them somewhat accountable for their mistakes. Again, this is not to pick on their mistakes. We all make mistakes. But there was no attempt by Barrons to get behind the logic of why they thought what they thought before, to see how that might shed some light on what they think now.
Also, while corporate America has talked about making changes, and Im sure some companies have actually done so, change is still strongly resisted. That notion was driven home for me by a recent op-ed piece in The Wall Street Journal titled The Best Option. It was written by Wick Simmons, who is the chairman and chief executive of the Nasdaq Stock Market. I know I am going to be guilty of using too broad a brushstroke here. I will admit that before going in. But I believe that he is basically acting as a shill for corporate America, or more properly, for those in corporate America who dont want things changed, as pertains to the tax treatment of options.
Abject apologia
The Wall Street Journal has run no shortage of op-eds that I have taken issue with -- for example, those that support Alan Greenspan or the new economy. (The Journal, as I have pointed out in the past, is one newspaper that tried to dignify the notion of a "new economy" by capitalizing the letters "n" and "e.") But this one by Simmons might take the cake in terms of falsehoods and absurdities.
Now before I talk about the specifics in this article that made my blood boil, lets just be clear about one thing. As everyone knows, corporations DO NOT EXPENSE options. But I think what people tend to forget is that not only do corporations not expense options, they get another goody as well: the ability to deduct from their corporate taxes the amount of income that their employees earn upon exercising their options.
Let's put the windfall of this deduction into perspective. A company whose employee earns $1 million by exercising his options gets two breaks in the process. First, the company may choose now not to report the options exercise as an expense in reports to investors. Second, the company is permitted to claim that same amount, $1 million, as a tax deduction. The result for the company is higher reported profits PLUS the tax break.
Throughout the mania, as stock prices went to the moon, lots of companies received outsized tax breaks based on the stock-option gains of their employees. Much of the cash you see on the balance sheets of companies that dont generally generate lots of cash (like tech companies) is there for this reason.
Status-quo stock quotes
Conveniently, people who tend to defend stock options never talk about how corporations have their cake and eat it, too. This is not to say that I believe expensing options is the only way to go. I am generically in favor of reducing taxes.
But in this case, I don't think a corporation should be permitted a tax deduction based on how crazy its stock price gets. If that wasn't an incentive to try to paint a rosier picture than exists, I don't know what is. Again, the fact that proponents of the status quo want the right to deem something expense-free and then receive a freebie like this strikes me as completely ridiculous. It is nothing more than a subsidy, or worse, corporate welfare.
Wicks miracle works
Rather than delve into that, right out of the gate Simmons relies on arm-waving and hyperbole to try to prop his absurd case. He says, Stock options have a proven (the emphasis is mine) power to transform industries and accelerate national prosperity. What they have a proven ability to do is to enrich insiders and employees. This is not to say that is bad, but to make his claim is a step way too far.
He then says, In the last two decades, entrepreneurs, new companies and ambitious visionaries moved the worlds fulcrum (the emphasis is mine) to the U.S., motivated largely by stock options. When given the right incentive, our economy roars. I would make the argument that what the options succeeded in doing was to exacerbate the move to speculate in the U.S. stock market. Speculation came about thanks to the Feds decision to provide too much liquidity to the system. Corporate chieftains had an incentive to goose stock prices because of the options.
Chieftains bathe in bay of impunity
To digress for a moment, the real crime was the Private Securities and Litigation Reform Act of 1995, which paved the way for corporate chieftains basically to lie without fear of being sued.
This safe-harbor law was an attempt to stop the frivolous claims on the part of certain ambulance-chasing class-action attorneys. (I should add that not all class-action claims are frivolous.) But of course, in an attempt to fix one problem, we created another problem. So, if were ever to clean up corporate America, we must again attach penalties to corporate lying, without unleashing ambulance chasing. This is not an easy problem to fix, but with all the bright people in America, Im sure it can be done.
Simmonizing over history
So, returning to Simmons claims, he makes it sound as though America exists in two forms: BO (before options) and AO (after options). Before options, we were an economic wasteland, roaming around in hunter/gatherer mode. After options, we magically awoke to the 21st century. As if that notion werent stunning enough, he then talks about how expensing options wont create any greater transparency, but will in fact further obfuscate a companys financial situation and punish its employees.
This is utter nonsense. It wont obfuscate anything. The obfuscation comes via corporations receiving the tax benefit from an expense they never claimed. And where was it written (not in the Simmons piece, for sure) that just because options may have to be expensed doesnt mean employees cant get them? Folks who do their homework will still ferret out what companies are worth, even if options are expensed.
Now Simmons makes perhaps the most absurd claim: Without the ability to attract talent and offer recruits a stake in the companys financial success, the new sprouts may never grow into the next generation of high-tech multinationals. So what does he think is going to happen here? People will just refuse to work and go on the unemployment line? Again, theres no reason why companies cant offer options, even if they are expensed, or give restricted stock.
Sword of GDP Damocles
But as if there werent already enough arm-waving in his case, Simmons proceeds to cite a rather stunning statistic to support his premise: According to a recent study, eliminating stock options would cut 3.5% off GDP over the next decade -- a staggering $2.3 trillion loss of economic output. Now I havent seen this study, and he doesnt identify it, but I can only wonder who cooked it up, and what assumptions were made to arrive at those statistics.
Finally, he caps off a piece riddled with nonsense by opining: The key to the U.S.s unprecedented economic prosperity is a system that recognizes the best talent and ensures that it is always available to the most promising ventures. I dont see how expensing stock options is going to change capitalism in America. Capitalism made us a great country a whole lot of years, say a couple hundred, before stock options were wildly prevalent and potentially abused.
Berkeley on bitter reporters
Meanwhile, I would just note that Simmons is not alone in voicing shrill opposition to the expensing of stock options. On Jan. 22, his colleague at the Nasdaq, Vice-Chairman Alfred R. Berkeley III, penned an absurd letter to the Financial Accounting Standards Board (the letter was referenced in a Jan. 29 story in the Financial Times) that was replete with wild claims. Berkeley labeled accountants "the shareholder's rights crowd. Then, setting his sights on the media, he said, "Most reporters are wage-slaves to mature, consolidated empires. These smart, ambitious knowledge workers stand almost no chance of earning a lot of money, and even less of earning ownership in the newspapers or magazines they work for. Smart as can be, and oh-so-human, it is easy for them to lash out at stock-options schemes they cannot have."
But here is perhaps his most astonishing claim: "The inability of workers to own and accumulate productive assets is at the heart of the discontent that drives able-bodied people to street protest, guerilla warfare and terrorism." (Perhaps if stock options are expensed, Berkeley will want to stock up on plywood and nails, in preparation for all those disenfranchised malcontents set to storm the Nasdaq "gates.") I don't think I even have to opine on how absurd that is.
The morality mandate
In any case, I just have to shake my head when I read such gibberish emanating from high places. (In the case of the Journal, I don't know which is the greater outrage -- the preposterous claims in Simmons' op-ed piece, or the paper's decision to publish it.) Again, I am not here to champion the view that options need to be expensed, but I dont think that corporate America should be able to have it both ways. And, as I said earlier, if we really want to fix what is wrong with corporate America, there has to be some penalty for corporate shenanigans. That is not optional.
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