Enrique Diaz-Alvarez enrique at ee.cornell.edu
Sun Mar 12 18:53:56 PST 2000

Jordan Hayes wrote:

> From enrique at ee.cornell.edu Sun Mar 12 14:17:16 2000
> On the other hand, if you can show that B-S significantly
> overestimates the value of options, that'd probably put
> you in the running for the Nobel prize.
> Well, a few points:
> * BS just gives you a theoretical price _at the moment you calculate_
> so it says nothing about the value of that option in the future.

Well, yeah. The company could give that option to the employee. Or they could sell it at that moment in the market and get cash. All the differences between employee's stock options and actually traded options, of which I am perfectly aware, are tangential to the fact that those options have *some* value, which is given to the employee, but not counted in reported earnings.

> Are you just saying that accounting is tricky?

Deciding whether to price the options when given or at exercise or in some other way is tricky. Ignoring a major business expense altogether is fraudulent, I think.

> But the absolutely *should* be expensed at some point,
> since they burn cash.
> But issuing the stock in the first place wasn't income; buying it
> back shouldn't be an expense.
> And that would make most NASDAQ companies look much worse
> than they do now.
> It just bums you out that investors don't understand the dilutative
> effect that options have on a stock?

In theory the effect may be only dilutive, but since management, for obvious reasons, almost exlusively would rather burn cash repurchasing shares than issue new ones, the actual effect of options is to redirect business profit towards employee's (largely upper management's) pockets, rather than diluting ownership. And I think accounting definitions should reflect reality, to the extent that it's possible.

But I agree that the options as expense/dilution debate is largely metaphysical, and barren, since the net effect is the same: to redistribute wealth from shareholders to insiders. The main point stands: this redistribution is massive, and unaccounted for in the P/E ratios, so the actual valuation is much worse than a mere 400 P/E ratio.

The investors we are talking about here are the rich and stupid, for the most part. I am starting to think that parting them from their money is a sort of public service, but I am still very interested in the mechanics of the separation.



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