It’s back. The battle over stock-option accounting is rearing its ugly head again. This time it’s a transatlantic showdown between U.S. companies–including General Electric, Compaq, Sun Microsystems, and Oracle–and the London-based International Accounting Standards Board (IASB), the organization charged with establishing common accounting rules for companies in the European Union by 2005, and ultimately the United States and the rest of the world.
Under current U.S. GAAP, employee stock options are valued on the date they are granted using the intrinsic value accounting method. As long as companies fix an option’s exercise price at the prevailing market price on the date of grant, no expense is booked on the income statement. This favorable treatment, embodied in FAS 123, was the result of nine years of exceedingly nasty debate between the Financial Accounting Standards Board and the U.S. corporate community.
Then, late last year, the IASB proposed that options be measured at fair value on the date they vest with employees, and that the compensation expense be accrued over the vesting period of the options. Not surprisingly, the U.S. corporate community came out swinging. “Our initial reaction…is one of dismay,” wrote Philip Ameen, controller of GE, in a letter to David Tweedie, chairman of the IASB. Ameen, a committee chair of Financial Executives International, suggested that the issue could be a deal breaker for the international accounting standards movement, and predicted a “quick erosion of corporate participation and support” if the IASB pushed the stock-option issue.
“Conceptually, most people believe that options are a compensation expense,” says Robert Herz, a partner with PricewaterhouseCoopers LLP and one of 14 members of the IASB. “But the issue of measurement is a very difficult one.”
Essentially, U.S. corporate leaders argue that the fair value of employee options cannot accurately be determined. Unlike exchange-traded options, they have vesting periods–usually two years or more–and they can’t be sold or transferred to another person. Neither the Black-Scholes option-pricing model nor any other derivative-valuation method can accurately incorporate these characteristics into their methodologies. Therefore, says a U.S.-based group dubbed the International Employee Stock Option Coalition, the expense shouldn’t be recognized in financial statements.