Expensing Isn't the Only Option: Alternatives to the FASB's Stock Option Expensing Proposal

50 Pages Posted: 9 Aug 2004 Last revised: 28 Sep 2009

Date Written: August 9, 2004

Abstract

This article reviews the arguments for and against the proposal of the Financial Accounting Standards Board (FASB) to require that corporations expense options. It identifies two major goals of the proposed rule: (1) clarity in financial statements, and (2) a reduction of corporate fraud by removing the incentive of options. To address these two goals, the article adopts a framework of Information Reforms v. Rules of the Game Reforms. The article starts with a history of FASB Statement No. 123 (Accounting for Stock-Based Compensation) and also analyzes proposed legislation in Congress attempting to block the measure, the proposed Stock Option Accounting Reform Act. The article reviews the opinions of leading economists on the accuracy of the option valuation schemes advocated by the FASB and concludes that the models are too easily manipulated to advance the FASB goals of clarity in accounting. The article concludes that neither the FASB proposal nor the legislative proposal advances the goal of clarity in financial statements.

The article suggests alternative measures that would better serve the interests of investors. It argues that a more accurate solution to the expense problem would be to adopt the IRS method for valuing stock options: intrinsic value at date of exercise. This accounting method tracks the cash flow out of the corporation since it reflects either an actual repurchase of shares issued by the company or a lost opportunity cost. In addition, the article proposes that corporations be required to use only fully diluted, in-the-money capitalization when computing EPS. This measure would address the FASB's concerns that the employee is given a valuable equity instrument at date of grant without that being reflected in the company's financial statements.

Finally, the article reviews the literature analyzing the impact of the FASB proposal on companies and the economy as a whole. The data shows that the FASB measure will not result in a reduction of corporate accounting fraud and that it will result in a loss of productivity among American firms that use options to incentivize workers. The article argues that the FASB proposal should be considered independently from considerations such as a reduction in fraud. The measure should solely be considered as an Information Reform, which by its nature is meant to improve the clarity of information rather than modify behavior. Modifying the behavior of executives who commit fraud, or boards of directors who make large option grants, requires more fundamental Rules of the Game Reforms rather than Information Reforms. Typical Rules of the Game Reforms would shift the power from management and the Board of Directors to shareholders and might include restrictions on the sale of executive stock so as to better align the interests of shareholders and employees.

Keywords: Financial Standards Accounting Board, stock options, expense accounting, financial statements

JEL Classification: M41, M44, G38, J33, K10, K22

Suggested Citation

Templin, Benjamin A., Expensing Isn't the Only Option: Alternatives to the FASB's Stock Option Expensing Proposal (August 9, 2004). Journal of Corporation Law, Vol. 30, p. 357, 2005, Thomas Jefferson School of Law Legal Studies Research Paper No. 573162, Available at SSRN: https://ssrn.com/abstract=573162

Benjamin A. Templin (Contact Author)

Thomas Jefferson School of Law ( email )

701 B Street
Suite 110
San Diego, CA 92101
United States
619-961-4317 (Phone)

Do you have negative results from your research you’d like to share?

Paper statistics

Downloads
763
Abstract Views
5,225
Rank
60,984
PlumX Metrics