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Stock Option Costs And Accountability

The direct cost to shareholders of stock16%.10 These cost effects extend for many
option compensation is the dilution of theiryears, depending on the life of the options.
ownership interest. A common managerialAt many companies, options have a life of
response to the dilution is to buy backfive years. Increasingly, companies extend
outstanding shares. The trouble with thattheir  lives  to  as long as 10 and 15 years.
solution is that it devours corporate funds
that might be more profitably deployed.Accountability
Shocking indirect costs are accounting rules
that fail to require employee stock optionsLegal rules are ill equipped to police
to be recorded as an expense on the incomeexecutive compensation. The general stance of
statement. This translates into earnings perU.S. courts is to evaluate compensation
share figures that overstate actual earningsissues, if at all, under a waste standard.
for companies with executive stock optionsThis standard rarely upsets corporate
outstanding. Even the diluted earnings perdecisions. Waste requires pretty much the
share  figure  does  not reflect these costs.irrational trashing of corporate assets in
ways akin to dumping truckloads of cash into
Accordingly, you must adjust earnings figuresthe Hudson River. In the case of executive
for the cost of options. Doing this is notcompensation, U.S. courts are quite
easy, however, for not all information isdeferential  to  management  indeed.
necessarily found in the financial
statements. You need to examine the footnotesAs for securities disclosure laws, the SEC
for something called overhang, which is therequires substantial and focused disclosure
percentage of the company that outstandingof top executive compensation in comparative
stock options would represent if they wereperformance charts. Nevertheless,
exercised. The average percentage hascorporations continue to structure executive
mushroomed from under 10% a few years ago tocompensation packages so that they don't show
nearly  15%  now.up in the bottom-line numbers. For example,
after accounting standard setters ruled that
Still, the actual cost of options is nota reduction in the exercise price of a
presented directly, though there is somepreviously issued option had to be recorded
footnote disclosure about this. The real costas an expense on the income statement, many
equals the price at the time of exercisecompanies chose instead to extend the life of
minus the amount the executive pays (thethe  option.
exercise price). This is the truest measure
of cost because the company could haveWithout effective legal or accounting
generated that much by selling the optionedregulations, the chief job of policing
shares to others at the prevalent priceexecutive compensation lies with the
instead of at the option price. The cost ofcorporate board. Board members must insist
executive stock options is substantial,that executive compensation peg individual
averaging about 5% of annual earnings amongcontributions to corporate performance.
S&P 500 companies and in some cases amountingMeasuring executive performance by business
to half of reported earnings, including atprofitability is the most definitive
Yahoo!, Polaroid, and Palm.9 In less dramaticyardstick with regard to shareholder as well
but still striking examples, if stock optionsas labor interests. When measuring
were recorded as a cost, the 1999 earnings ofperformance, companies should reduce earnings
some major companies would be slashed: Cisco,by the capital employed in the relevant
24%; Microsoft, 12%; IBM, 8%; and Oracle,business or by the earnings the firm retains.



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