Companies must start expensing employee stock options in earnings statements next year, U.S. accounting rule makers declared yesterday, a move that could signal the end of a long-standing...

Share story

NEW YORK — Companies must start expensing employee stock options in earnings statements next year, U.S. accounting rule makers declared yesterday, a move that could signal the end of a long-standing bookkeeping practice that many argued allowed the masking of a key compensation cost.

The rule by the Financial Accounting Standards Board (FASB), proposed to take effect in mid-2005, could still be blocked by fierce opposition from parts of corporate America, particularly Silicon Valley and its supporters in Congress.

“There’s still a very strong lobby trying to stop the rule,” said G. Michael Crooch, an FASB member.

Most Read Stories

Unlimited Digital Access. $1 for 4 weeks.

FASB rules must be backed by the Securities and Exchange Commission (SEC) before taking effect, although the commission has historically signed off on the independent panel’s decisions.

The rule, which drew immediate fire from technology trade organizations, would make a stock-option grant a compulsory cost item for companies that award options as part of employee compensation. An option is the right to buy a stock at a preset price.

Until now, companies could merely mention the value of the options in the footnotes of financial filings. While some big companies like Microsoft and Coca-Cola have already started expensing stock options, some other big companies, mostly technology-oriented, have opposed the practice.

About 750 U.S. companies today voluntarily expense employee stock options.

“Recognizing the cost of share-based payments in the financial statements improves the relevance, reliability and comparability of that financial information and helps users of financial information to understand better the economic transactions affecting an enterprise and supports resource allocation decisions,” Crooch said.

Technology companies have argued that expensing them would deter companies from issuing options, limiting their ability to lure and retain talented executives.

Criticism was still coming in yesterday. The National Venture Capital Association said FASB’s move will harm young and private companies.

“Now that the FASB has issued its final ruling, it’s time for policy-makers and regulators to step in on behalf of our country’s entrepreneurs and fix the quagmires that have been created here,” said Mark Heesen, the association’s president.

Heesen said he expected the SEC to take a hard look before it approved the rule.

FASB’s move on stock options also champions its independence, which came under serious threat a few months ago when some of the biggest technology companies wanted Congress to block the proposal.

FASB, however, remained unfazed and stuck to its deadline of coming out with the rule by year-end.

“Despite intense political pressure to reverse course, FASB demonstrated its commitment to reform and acted today in the best interest of the investing public,” said Sen. Peter Fitzgerald, R-Ill.

One problem that FASB faced this year was opposition to the recommended valuation method for the options. Historically, the Black-Scholes model has been used, but some experts have questioned its validity for some options.

These experts point out that the Black-Scholes method was crafted to value options that constantly trade on stock exchanges, while employee options are held by employees for at least three years. The holding period has an effect on volatility of an option price that the Black-Scholes method does not consider.

Bob Herz, FASB’s chairman, said the accounting body was not going to specify which valuation method to use, but he encouraged companies that opt for Black-Scholes to take a look at the Lattice model, which he called “more refined.”

Information from Bloomberg News

is included in this report.