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Optional expensing of options?
Big tech firms like Cisco and Intel should give up fighting options expensing.
May 8, 2003: 2:15 PM EDT
By Paul R. La Monica, CNN/Money Senior Writer

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NEW YORK (CNN/Money) - John Chambers, CEO of Cisco Systems, is a smart guy. But he is dead wrong on the issue of expensing stock options.

Many companies, especially technology firms, grant their employees stock options, the right to buy shares at a later date at a specified price, as part of their compensation. CEOs have argued that unlike salaries and wages, options should not be listed as an expense because it is difficult to put a value on the option until it is exercised.

Currently, companies can choose to expense options or clearly state in their financial statement what the expense would be. The Financial Accounting Standards Board (FASB) is pushing to make options expensing mandatory. Big tech firms are fighting this tooth and nail.

During Cisco's (CSCO: Research, Estimates) fiscal third quarter conference call on Tuesday, Chambers made an impassioned defense of options and why they should not be expensed. He argued that if tech giants have to include options expenses on their books, companies would not give out as many. And that, Chambers continued, would lead to more tech related jobs going overseas.

Furthermore, he even maintained that big techs like Cisco, Intel (INTC: Research, Estimates) and Microsoft (MSFT: Research, Estimates) are doing smaller tech firms a favor by fighting this fight because if smaller companies had to expense options, it would be tougher for them to survive and compete against established rivals.

Options ain't what they used to be

"What options expensing will determine is job creation and job loss," said Chambers during Cisco's conference call. "This is why we are debating it so strongly and I'm proud to champion it."


Given the woeful state of the economy, specifically the large number of layoffs in tech during the past three years, it seems unlikely that most tech workers would refuse work if they didn't have stock options.

Disappearing profits
Earnings for four tech giants wouldn't be as high if they had to expense options.
CompanyEarnings (reported)Earnings (incl. options expense)
Cisco Systems$1.9 billion$373 million
Dell Computer$2.2 billion$1.4 billion
Intel$3.1 billion$1.9 billion
Microsoft$7.8 billion$5.4 billion
* Net income for the latest fiscal year
Source:Company reports

"In the past, you had to lure good talent with options. But it's a sign of the times. Across the board most people are happy to just have a job," said Michael Cohen, director of research for PacificAmerican Securities.

Also, it's not as if there aren't other ways to reward employees. To that end, one major tech company announced this week that is changing its compensation practices. Dell Computer is going to be cutting back on options and has decided to give some senior executives bigger cash bonuses instead.

Paying people in cash? How novel.

I don't see anything wrong with giving people cash. It's more transparent because it would have to be listed as a real expense. If companies set performance-based goals (i.e. revenue growth) then you would hope that higher compensation expenses in a given quarter could be offset by stronger top-line growth. So it's not as if giving people cash will destroy earnings.

Now Chambers would argue that without options, rank-and-file employees would no longer be able to have an ownership stake in their company. That's absurd, too.

Most large tech companies have stock buyback programs. Part of their rationale is to offset potential dilution after employees exercise their options. That has resulted in a minimal change in share count for a lot of tech companies over the past few years.

Big earnings hit if options are expensed

Here's a thought: Instead of buying back stock to offset options grants, why can't companies buy back stock and then dole out the shares to employees, with restrictions on when the person can sell? That way, an employee still has an ownership stake in the company and can participate in the stock's upside. But that would be an expense, too, and would result in a real hit to earnings.

In the end, that's the problem. Earnings -- not fear that everyone in Silicon Valley will leave for India or Korea -- are at the heart of the entire stock options debate.

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Earnings for Intel and Dell would have been more than 35 percent lower in their latest fiscal year if they expensed options. Cisco's fiscal 2002 profit would have been reduced by 80 percent.

This issue has been and will continue to be hotly debated on Wall Street, Silicon Valley and in Washington, D.C. In fact, a Senate roundtable about the expensing of options is taking place today.

Despite the intense lobbying from tech bigwigs, FASB should do what's right: make options expensing mandatory. If so, tech firms will adjust and keep innovating, no matter what Chambers and his cronies say.

"If our economy depends on options we have a huge problem on our hands. Please don't insult my intelligence that badly," said Alex Vallecillo, senior portfolio manager with National City Investment Co., and a proponent of expensing options.  Top of page

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