San Francisco Chronicle.
For many Silicon Valley executives, the mounting battle over stock options turns on a clash of cultures.
Critics who want options counted as an expense don't understand the valley and don't grasp the reasons for its success, they say.
Force companies to make the change, and their employees would lose a significant source of income and motivation as firms cut the number of options they give. Workers would stop thinking of themselves as owners of their firms, executives say. The 80-hour-a-week work ethic that defined the valley would fade.
"I would no longer have employee shareholders. I would just have employees, " said T.J. Rodgers, chief executive officer of Cypress Semiconductor Corp. in San Jose.
Those arguments, however, haven't dissuaded critics. A panel that sets international accounting standards proposed last week that companies count options as an expense on their earnings statements. The panel's American counterpart, the Financial Accounting Standards Board, may take another look at the issue as a result.
Many critics don't object to options as a way to inspire a staff. They just want companies to account for a kind of compensation that -- unlike salaries --
isn't part of a company's bottom line.
"You think that's the right thing to do? Terrific. Do it. Just account for it," said Mary Barth, a dean of Stanford University's Graduate School of Business and a member of the International Accounting Standards Board, which last week proposed expensing options.
The debate's outcome is far from certain. The FASB studied stock-options expensing during the mid-1990s but backed off under pressure from Congress.
Now, a year of corporate scandals has changed the dynamics of the fight. Some politicians who rose up to oppose expensing before may not want to risk the appearance of coddling business on such a controversial topic, with voters still incensed over the collapse of Enron and WorldCom.
Those pressures remain even after last week's election of a new Republican majority in Congress, said Richard Phillips, head of the securities group at the Kirkpatrick & Lockhart law firm and a former SEC staff member.
"It's much too soon to say the pressure for reform has lessened," he said. "The wheels have already been set in motion, and I don't think Congress is in a position to stop them."
Options allow their holders to buy a company's stock at a future date for a preset price. If the share price goes up after the option is issued, recipients can buy the stock at a discount and then, if they want, sell it at market rate, making a profit. When employees exercise the most common kind of option, their employer gets a tax deduction for the amount they recognized as income.
Current accounting rules require companies to tell shareholders about the financial effects of stock options -- but only as a footnote. Look deep into the fine print of a company's annual report, and you'll find a discussion of how options would have changed the firm's profits had they been counted as an expense.
The results can be sobering.
Internet equipment-maker Cisco Systems, for example, made $1.9 billion of net income in the year ending July 27, 2002, according to its most recent annual report. Had San Jose's Cisco expensed its employees' options, using the most common method of gauging their value, that income would have shriveled to $373 million.
That difference, however, isn't the only reason Cisco executives oppose expensing. Like others in Silicon Valley, they view options as part of their corporate culture, a way of instilling in all their employees a sense of ownership in the company.
"Why do you think they are so motivated?" asked Dennis Powell, Cisco's senior vice president of corporate finance. "The answer is because they are shareholders of the company. Why are they willing to stay as late as they're staying? Why do they ride coach everywhere they go? It's because they're spending the money as if it were their own."
Options existed before the technology industry's rise, but their use mushroomed as Silicon Valley grew. Startup companies short on cash seized on options as way to lure and keep top-flight engineers and executives.
"Very young companies can't afford to attract talent with big salaries," said Jim Jarrett, vice president of worldwide government affairs for chipmaker Intel Corp. of Santa Clara. "They do it by giving people a piece of the action. "
It became part of the valley's promise: Take a chance on something new, work hard and reap the rewards.
Tech executives have other reasons to object to the proposed accounting change.
Since companies don't spend cash to give an employee an option, figuring out their financial impact at the time they are granted involves deriving an estimate out of a mathematical model. The most common method, referred to as the Black-Scholes model, can yield wildly varying numbers from one year to the next.
"It's not like these things are unimportant or don't have value. The problem is they don't fit very neatly into the things we usually account for," said Rick White, chief executive officer of the TechNet public policy group, which opposes expensing. "The people who have actually gone through the Black- Scholes process have thought, 'Wow, this number has a lot of problems.' "
And yet options do have worth. When a company grants options, it gives away something of value for less than the market rate, said Brett Trueman, public accounting professor at UC Berkeley's Haas School of Business.
"It is an estimate, but there are so many estimates in earnings statements already," Trueman said. "And besides, if you put nothing down, that's clearly a bad estimate. I'd rather have something."
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