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[Phoenix]

So it seems the US government regulatory bodies have gone and completely lost their minds and are now rendering an opinion that corporations should be allowed to expense stock options. While the goal is to make financial statements more accurate (an admirable goal), a stupid side effect is that stock options are going to be given a value.

For those that don't know what stock options are, they are a benefit that many businesses use to give employees and opportunity to gain state in their employers business. But the key word here is opportunity - you still have to actually spend money and pay capital gains taxes to take advantage of this benefit. An option is in essence worthless until the time at which it is actually used by an employee, and many employees go through their entire careers with a company and never have an opportunity to utilize their stock options either because the stock isn't worth enough (and currently many employees have options that would cost more than their companies stock is worth), the company hasn't gone public yet, or after taking into account the capital gains tax the employee really doesn't get much out of the deal unless they have considerable volume of shares.

Perhaps the funniest part of the opinion was the attempt to justify why options should have a value at all:

While very different in nature and purpose, the potential gain that makes an employee share option valuable is similar to the potential gain that makes a lottery ticket valuable. An individual buys a lottery ticket because it gives the holder the right to potentially receive valuable assets (generally cash) in the future. The payment for the lottery ticket is similar to the option premium paid (cash or employee services) for the share option. Even if the probability of winning those valuable assets is extremely low, the lottery ticket still has value until the winning number is known (at which point the winning ticket’s value increases, and a losing ticket’s value decreases to zero). In contrast to a typical lottery ticket, which is valid for one drawing only, a share option is valid for multiple drawings (that is, each day a share option is outstanding can be viewed as an independent drawing because the value of the share can change, making the share option more or less valuable).

I say that if stock options have a "value" that can be valuated then my lottery tickets should have a value that I can write off on my taxes.


Source

 

[Azih]

So any company can increase the amount of 'stock options' it gives to its employees and earn a tax break?

 

[Ignatz Mouse]

Phoenix, you're missing the point. They *have* to expense stock options. Previously, not needign to account for stock options allows companies to do all sorts of ultimately problematic acts, including undermining the value of the company itself. Not a problem for the big boys, but smaller companies would do this since granting options to employees was essentially free, accounting-wise.

Most firms are not happy.

Anyway, this is a good thing. It's not about tax write-offs, it's about accounting for the value of the company.

Anyway, I work in options, and they do have a value. People buy and sell them all the time.

 

[fart]

fantastic. boy-ee it sure is a cowboy government for and by the working class, boys.

 

[McLesterolBeast]

Stock options are capital equivalents. Lottery tickets are recreational.

You'd have a pretty weak case trying to draw connections between how the two are taxed.... or rather, justify that there ought to be some sort of consistency when the two have very little in common.
The connecting principle was not with respect to how they ought to be taxed (in the article). The connecting principle is that the value of both is based on expected returns.

 

[Phoenix]

Stock options are capital equivalents. Lottery tickets are recreational.

You'd have a pretty weak case trying to draw connections between how the two are taxed.... or rather, justify that there ought to be some sort of consistency when the two have very little in common.

The point is that neither have any value until they are 'cashed in'. A stock option doesn't actually have any value until someone excercises it.

 

[Ignatz Mouse]

A decent layman's article on the topic.

http://www.chicagosuntimes.com/output/business/cst-fin-options17.html

 

[Phoenix]

Anyway, I work in options, and they do have a value. People buy and sell them all the time.

So lets say I have a few thousand options of SUN at an excercise price of $30 (Sun stock is worth around $5 bucks these days). What is their value?

 

[Ignatz Mouse]

The point is that neither have any value until they are 'cashed in'. A stock option doesn't actually have any value until someone excercises it.

Not true. Options are instuments traded on the public exchanges, and have a value based on the market, generally derived from Black-Scholes formul, plus whatever the market appetite is.

If you think options have no value, then how can they be bought and sold?

 

[Phoenix]

Not true. Options are instuments traded on the public exchanges, and have a value based on the market, generally derived from Black-Scholes formul, plus whatever the market appetite is.

If you think options have no value, then how can they be bought and sold?

My understanding of corporate stock options is that they are excercised by employees and the stock is purchased and sold via brokerage firms just like regular stock. But what we are talking about is expensing the value of an item that changes at least hourly. How do you account for that fairly? If I'm working for a company that has had no IPO and I'm sitting on 6K shares of stock, what is the value of those options? The companies stock has no value - I cannot excercise those options because I have no means to sell them. If so, I would be very interested in understanding this process. How do you sell stock in a company when the stock has no publicly traded value?

 

[Ignatz Mouse]

So lets say I have a few thousand options of SUN at an excercise price of $30 (Sun stock is worth around $5 bucks these days). What is their value?

Not much. I don't recall the B-S formula exactly, but it's essentailly the volatilty of the stock (ie, how much it's moving), the time until exercizable, a factor to account for the lost interest the money spent of the option would be making (time value of money), divided by two (50-50 chance of going up or down), and the difference from strike price to current price.

 

[Ignatz Mouse]

My understanding of corporate stock options is that they are excercised by employees and the stock is purchased and sold via brokerage firms just like regular stock. But what we are talking about is expensing the value of an item that changes at least hourly. How do you account for that fairly? If I'm working for a company that has had no IPO and I'm sitting on 6K shares of stock, what is the value of those options? The companies stock has no value - I cannot excercise those options because I have no means to sell them. If so, I would be very interested in understanding this process. How do you sell stock in a company when the stock has no publicly traded value?

If the company isn't public, the only value you could get for them is what some other party in the company would be willing to pay.


Back to the original point-- companies, especailly startups, liked options because they did not need to be accounted for. Hence, options given out freely. What the company was basically doing was giving away future equity in the firm without accounting for it, which led to a lot of dot-com abuse and execs making out like bandits on IPOs and the liek and then bailing. The cost to to company is not a conrete number, but as you note, changes hourly. However, it should not be accounted for as "free" either, which it was.

 

[Phoenix]

Not much. I don't recall the B-S formula exactly, but it's essentailly the volatilty of the stock (ie, how much it's moving), the time until exercizable, a factor to account for the lost interest the money spent of the option would be making (time value of money), divided by two (50-50 chance of going up or down), and the difference from strike price to current price.

Well if they have a value that is greater than a negative number then clearly accounting has got me baffled because I would say that they are worth -$25 dollars/share, you'd excercise them for a loss.

But I don't really want to debate this, I want to understand this. I have a good number of TWX shares and I've had thousands of shares in companies that weren't public. I assume that the shares of a company that aren't public are worthless because I cannot excercise them. I assume that the value of an option is the value of that option at the time I can excercise it. As such it seems strange to say that a company should expense something that won't really have a determinate value until its sold. I have friends at Sun Microsystems with thousands of shares of SUNW. So lets say that SUNW expensed those options one year, would they be able to claim some sort of loss now that the stock has tanked? Seems only fair since you're still sitting on those options.

Personally I think that stock options as a practice should be outlawed and that only tangible stock should be given because IT has a value at the time that its issues and can be purchased/sold at a known value at that time.

 

[McLesterolBeast]

Personally I think that stock options as a practice should be outlawed and that only tangible stock should be given because IT has a value at the time that its issues and can be purchased/sold at a known value at that time.

On what grounds? Options are issued with the interest of current equity holders in mind - or at least they SHOULD be, ideally. By forcing them to be recognized as tangibles, it's a good way to ensure that current equity holders interests arent compromised. It's true that, if such a situation occurs where a large amount of options are exercized (because it was desirable for the holders of those options to do so) - that the value of existing equity would decline proportionate to how much the option holders benefit. But that's the cost of 'chance'. Issuing options are another means of financing to a corporation. There's absolutely no _good_ reason to "outlaw" it.

 

[Phoenix]

On what grounds? Options are issued with the interest of current equity holders in mind - or at least they SHOULD be, ideally. By forcing them to be recognized as tangibles, it's a good way to ensure that current equity holders interests arent compromised. It's true that, if such a situation occurs where a large amount of options are exercized (because it was desirable for the holders of those options to do so) - that the value of existing equity would decline proportionate to how much the option holders benefit. But that's the cost of 'chance'. Issuing options are another means of financing to a corporation. There's absolutely no _good_ reason to "outlaw" it.

If a company has to expense them but the employee receiving them cannot convert them into anything tangible, what is the point? I favor getting rid of them because of what happens on the side of the people receiving them - not the current equity holders. Stock options have been used in too many instances as an incentive to get labor from people while paying nothing. So fine we'll expense them and now businesses will account for millions of dollars in options while the people actually receiving those options cannot excercise those options for the same millions of dollars. In many instances employees aren't at many businesses long enough to even excercise what options they DO get. A business can decrease its taxable earnings by tossing off volumes of useless options (because you can't excercise them upon receipt), especially if it knows that its future quarters are going to be shallow and the stock will be worth less than the options. It is the same motivation of some start-up shops that give employees thousands of shares in options - we just gave you a bunch of useless paper at a relatively arbitrary valuation rate.

 

[Ignatz Mouse]

Well if they have a value that is greater than a negative number then clearly accounting has got me baffled because I would say that they are worth -$25 dollars/share, you'd excercise them for a loss.

But I don't really want to debate this, I want to understand this. I have a good number of TWX shares and I've had thousands of shares in companies that weren't public. I assume that the shares of a company that aren't public are worthless because I cannot excercise them. I assume that the value of an option is the value of that option at the time I can excercise it. As such it seems strange to say that a company should expense something that won't really have a determinate value until its sold. I have friends at Sun Microsystems with thousands of shares of SUNW. So lets say that SUNW expensed those options one year, would they be able to claim some sort of loss now that the stock has tanked? Seems only fair since you're still sitting on those options.

Personally I think that stock options as a practice should be outlawed and that only tangible stock should be given because IT has a value at the time that its issues and can be purchased/sold at a known value at that time.

well, the options are either worth zero, or near zero. They dn't have negative value beacuse you aren't forced to excersize them.

Expensing the options is only done at grant-time, so underwater options would not enter into it. By definition, the option at grant time is worth exactly zero if exercized (moot point, since companies don't vest them to the employee generally until after some timeframe).

As far as outlawing them-- well, I don't see the reason to, but this accounting rule *is* designed to discourage the granting of options willy-nilly.

 

[Phoenix]

Expensing the options is only done at grant-time, so underwater options would not enter into it. By definition, the option at grant time is worth exactly zero if exercized (moot point, since companies don't vest them to the employee generally until after some timeframe).

I think my view on it lay in here.

Since they are worth zero at grant time, why would companies have to expense them (and write them off) since at that point they really don't have any value. I'm of the opinion that at best companies should be required to expense them when they are actually worth something (i.e. at the same schedule as the vesting schedule of the employee) because prior to that, the employee can't excercise them anyways. When I can excercise them, the company should have to expense them. Otherwise what's the point. My employer gives me 10K options and I leave the next day (so to speak). That just doesn't make any sense since the company in reality doesn't really give the employee anything tangible until such time as the employee can actually excercise them. Until then they aren't worth more than toilet paper - and I would argue that the toilet paper would be worth more.

If you were to die they don't pass on. If you leave they don't pass on. If the company is acquired in acquisition the old shares may or may not have any value at all. I say that the most fair position for both me as an employee and me as a person who doesn't want to see companies dumping options on people they know won't ever use them is to have the value of them set at the time of the grant, but expensed at the time they are actually useable.

 

[Ignatz Mouse]

It's worth zero *if excercized*. It has a value, based on its potential and the volatility and the term of the option. But more importantly, it has a *cost* to the company-- even if in the future-- that should be accounted for *at the time the contract (option) is created.* Otherwise, comapnies can (and did) create incentives out of thin air that are going to cost them huge in the future.

Granting an option is like promising to sell a piece of yourself at a discount in the future, assuming that you are going to increase in value. While you are correct that that expense is over-costed if the value of hte company goes down, it's a huge cost to the company if it goes up-- and that's just what happened to a lot of tech companies in the last 8 years or so.

Expansing options ensures that employers don't hand them out like candy, which is a bad deal for the employee if the stock tanks, and a bad deal for the company if it goes up (or at least, a deal which ought to be accounted for).


Smarter people than me think this is a good idea, and I trust them. I know a guy who's an executive comp consultant and he's been on a crusade to make this fair for everybody.

 

[Phoenix]

It's worth zero *if excercized*.

Which to me, the recipient, means that it has zero value.

It has a value, based on its potential and the volatility and the term of the option. But more importantly, it has a *cost* to the company-- even if in the future-- that should be accounted for *at the time the contract (option) is created.* Otherwise, comapnies can (and did) create incentives out of thin air that are going to cost them huge in the future.

But this doesn't stop them from doing that. Expensing options only cuts into profits and gets written off. A company can still expense options and hand them out like candy as many of the Fortune 500 who voluntarily started expensing them yet continue giving out yearly stock grants illustrates. You can get a statistician to show what your actual stock yields are from options and you'll know how many actually get converted into actual shares so you'll know how much you're dilluting investor equity. Its a gamble and the people who lose are the recipients of these worthless pieces of paper. Microsoft had the right idea when they stopped granting options and instead started granting shares - hell if you're expensing it, why not just give people the actual shares. You're paying for it like you are.

Granting an option is like promising to sell a piece of yourself at a discount in the future, assuming that you are going to increase in value. While you are correct that that expense is over-costed if the value of hte company goes down, it's a huge cost to the company if it goes up-- and that's just what happened to a lot of tech companies in the last 8 years or so.

Yes no kinda for most of the Valley. Many of the companies died long before the employees were actually able to vest their shares or before most employees knew that the company was going to tank. Most came in to work and found their stuff in boxes and their stock was already worthless. This STILL doesn't resolve that problem. The person receiving the options still isn't receiving anything and that's the person I'm concerned with. The corporation is just going to write it off as an operational expenditure - the employee is not so lucky. The .com era can't be blamed on stock options any more than it could be blamed for companies writing loans to executives, not tieing their compensation to corporate success, and not having a business model that actually made money. All of that was termed the "new economy" or as I call it "wishconomics".

Smarter people than me think this is a good idea, and I trust them. I know a guy who's an executive comp consultant and he's been on a crusade to make this fair for everybody.

True, but there are also smarter people than me who think its a bad idea. As I look at the situation from the perspective of a person who has had them before I see a marked benefit for a company and none for the person who receives the options.

 

[Ignatz Mouse]

Well, that's probably why my company gives out a LOT less options than it used to. The only reason to do so is to incentivize employees to make the company worth more. The upside of options is bigger than the upside of an equivilent cost of stock.

Anyway, what you say about statisticians is exactly what companies are now starting to do. It's fair to the shareholders. As far as writing them off-- well, that cuts into profits, and shareholders (and the larger market) care about profit.

Anyway, looking around I didn't really find any arguments against, except one which said it was a "fad" without really saying why it was a bad idea. What's the downside?

 

[Ignatz Mouse]

I guess what you're missing is that this new ruling does exaclty what you want-- discourage giving out options. Generally, companies give much less compensation as options than they used to, especially to those who can least afford it. Execs still get some, but generally most employees don't anymore. As you say, stock grants are more common.

 

[Phoenix]

Anyway, looking around I didn't really find any arguments against, except one which said it was a "fad" without really saying why it was a bad idea. What's the downside?

The downside is that you leave it up to businesses now to use options as a mechanism to change their tax burdon with the knowledge that they won't actually dillute actual shareholder equity. There is a whole lot of money that's being "created" which doesn't really exist.

For example my accountant tells me that I can change my tax bracket by giving out 10K options of stock across the company and while there is an upfront cost in doing so, we get a lower tax status that we can exploit for other gain. In addition he tells me that at most over the life of those shares only 2K of them will be excercised.

Another example is if I'm granted 1000 shares of stock my employer pays for granting me those shares. If I never excercise those shares was my prior employer just paying for the right to grant options as they don't get that money back. (This case is why it doesn't make sense to charge people on grant - but on excercise)

Another example, I run a small business and I want to attract a good CEO but I don't have a lot of cash on hand. I can't use options any more because it actually costs me a considerable amount of money to grant the CEO options on future ownership and I don't have cash on hand. How do I as a small business put together a good and attractive package to bring in a good CEO or even prospective talent based on the companies future performance now?

Another example, my employer doesn't give out stock options anymore because they can't afford to. They don't replace that benefit with anything except maybe blockbuster gift cards and frozen turkies (and that's happening).