Expensing Stock Options On December 15, 2005 the Financial.

Expensing Stock Options On December 15, 2005 the Financial… Expensing Stock OptionsOn December 15, 2005 the Financial Accounting Standards Board required companies that grant stock options to employees to expense these stock options on their financial statements. Prior to this, companies only needed to footnote the effect of options on their financial statements. Needless to say, there are some very strong opinions on both sides of this argument. At the heart of the matter is that SFAS 123R (the FASB statement requiring this disclose) will seriously hamper how certain companies compensate employees (young, technology, etc.) by making stock options too expensive to grant. Below are excerpts from the Financial Accounting Standards Board, the International Employee Stock Option Coalition and Warren Buffet regarding this issue. Please consider these positions and provide your opinion as to whether stock options should or should not be considered as a company expense that needs disclosure on corporate income statements. * * * * * Financial Accounting Standards Board (from its FAQ for SFAS 123R) Q3. Why does an employee share option have value?An employee share option has value because it gives the employee the right to benefit from increases in the share price over the exercise price during the option’s contractual term. . .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).Just as millions of lottery tickets are purchased each year, millions of share options are bought and sold each year in the United States on organized option exchanges, the largest of which is the Chicago Board Options Exchange (CBOE). The CBOE reported that nearly 270 million contracts trade annually; 159.3 million of those contracts related to options on equity securities. 1 Investors pay significant amounts to obtain rights to potentially benefit from future increases (or decreases) in the price of individual equity securities and equity security indexes. While exchange-traded share options are different from employee share options (refer to Q11), both types of options have value for the same reason.  * * * * * International Employee Stock Option Coalition position (From their Website) Accounting Integrity Mandated expensing of stock options is without any clear or generally accepted accounting rationale.It won’t provide a more accurate view of earnings, add any information not already included in the financial statements, and won’t even lead to equal treatment of different forms of executive pay.Existing models were not designed to account for dynamic employee stock options that can be exercised over several years.A review of stock option expensing models from 1999-2004 show radically different valuations based on volatility of the stock market.Economic Impact 79% of stock options holders earn less than $75,000 annually.Discouraging stock options could result in over $2.3 trillion in lost output over the next decade (Employment Policy Foundation).Federal, state and local governments could lose up to $563 billion in tax revenue over the next 10 years (Employment and Policy Foundation).  Innovation Impact “Innovation will be the single most important factor in determining America’s economic success through the 21st Century” (Council on Competitiveness)”Innovation generates the productivity that economists estimate has accounted for half of U. S. GDP growth over last 50 years” (Rational Exuberance, Michael Mandel)”Knowledge intensive companies generally have a market value that is significantly higher than their book value” (National Innovation Initiative)  * * * * * Excerpt from Berkshire Hathaway Annual Report The simple fact is that certain CEOs know their own compensation would be far more rationally determined if options were expensed. They also suspect that their stock would sell at a lower price if realistic accounting were employed, meaning that they would reap less in the market when they unloaded their personal holdings. To these CEOs such unpleasant prospects are a fate to be fought with all the resources they have at hand, even though the funds they use in that fight normally don’t belong to them, but are instead put up by their shareholders.Warren BuffettBERKSHIRE HATHAWAY INC.Chairman-Letter to shareholders2004 ANNUAL REPORTAccounting Business Financial Accounting FI 422

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