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August 06, 2002
Stock Option Expenses and Unintended Consequences

Today's Wall Street Journal has an article by Jonathan Weil and Theo Francis entitled Deciding Stock Options' Value Will Be Tricky Task for Firms. The article ends:

Most companies that have declared their intentions to recognize stock-option compensation expenses each quarter would feel only a modest pinch to the bottom line from the change. General Electric said in a footnote to its 2001 annual report that expensing stock-option compensation would have reduced net income by about 2.2%; doing so in 2000 would have cut earnings by about 1.8%. Similarly, Procter & Gamble said expensing the options it granted employees and executives would have cut net income by about 11% in 2001 and by 5% in 2000. At Coca-Cola, earnings would have fallen by about 5% last year and 8% in 2000. High-technology companies' earnings likely would be hardest hit by a change in accounting rules. For example, Intel Corp., the semiconductor maker, told investors that its 2001 earnings would have fallen by 80% if it had counted stock-option grants as an expense, although the expense would have lowered 2000 earnings by just 8%.

The Intel situation scares the hell out of me. The only possible explanation for the difference in the two years is that in 2000 Intel's stock performance was fine and in 2001 it was not. Thus, Intel was forced to issue many more new shares to calm nerves and buttress the loyalty of key employees in a down market without using precious cash. The net effect will be that in periods of decreased revenues and incomes - which is what makes Intel stock decline in the first place - Intel and others like it will be forced to place further artificial pressure on its stock to arguably do what is best from a public policy and long term shareholder value standpoint.

I think the vast majority of the supporters of expensing options are looking at the issue without seeing this unintended consequence. However, I'd also lay a wager that this is exactly the type of behavior and effect that Warren Buffett and non growth companies like GM want to see.

Posted by hoffmang | August 06, 2002 03:24 PM


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