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Running out of options
Shareholders of HP approved a proposal to expense stock options. Techs need to face the inevitable.
March 18, 2004: 5:31 PM EST
By Paul R. La Monica, CNN/Money senior writer

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NEW YORK (CNN/Money) - Some tech investors are starting to show that they're sick and tired of companies not having to include the expense of stock options programs on their income statements.

It's about time.

More than 1.2 billion Hewlett-Packard shares were voted in favor of a measure to expense stock options at the company's annual meeting on Wednesday while 921 million shares opposed it.

The proposal was recommended by the Massachusetts Laborers' Pension fund, which owns shares of HP. The fund has called for options expensing at other companies, including Eastman Kodak and NCR. The fund is also behind similar votes that will take place at the next shareholder meetings of Texas Instruments and Novell.

Pressure to expense will intensify

Although the options expensing vote was a non-binding proposal (i.e. HP's board doesn't have to act on the results) it should still send a strong message to tech companies. The days of claiming that options are not a real expense are coming to an end.

Last year, shareholders of Apple Computer, Citrix Systems and Veritas Software approved similar measures to expense options.

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And some techs have even voluntarily decided to take action when it comes to stock options. At the beginning of last year, began expensing them. In addition, Microsoft agreed to put an end to its stock option program in September. It's now giving out restricted stock instead and is including the expense in its quarterly earnings.

Of course, there's a good chance that this will be a moot point soon since the Financial Accounting Standards Board (FASB) is expected to mandate that all companies expense options. Such a rule might be put into place by the end of this year or early 2005.

Still, it's encouraging to see that shareholders are making this an issue. And it will be interesting to see if any tech companies respond before they are forced to by the FASB. Such companies might win some plaudits from shareholders by doing so.

"This will continue to be a hot topic for a lot of tech companies," said Paul Hodgson, senior associate with the Corporate Library, a research firm focusing on corporate governance. "Companies are beginning to realize that their time is limited for ignoring the cost of options."

Is it about jobs or earnings?

But many large tech companies, including Cisco Systems, Intel and Oracle, have vociferously defended the practice of not expensing stock options. One of their main gripes is that the current method used to value options, the Black-Scholes model, is extremely faulty. Some have jokingly referred to it as the Black Holes model.

But while Black-Scholes may have some flaws, it does seem to be better than just blissfully ignoring options as if there was no financial cost to them whatsoever.

Tech Biz
Corporate Governance
Stock options
By Paul R. La Monica

Large tech companies have also claimed that if they are forced to expense options, they will probably then give out fewer options as compensation to employees. As a result, this will make it tough for these companies to retain top talent, the companies contend.

I've said before that this argument is a crock. Given the state of the job market, I think many tech employees are happy with jobs...period. And as Microsoft has shown, options don't have to be the only way to reward employees.

"There are many ways to compensate employees that allow people to retain talent," said Linda Priscilla, manager of corporate and investment relations for the Laborers'-Employers Cooperation and Education Trust. Priscilla is the corporate governance advisor to the Massachusetts Laborers' Pension fund.

Jobs aren't the issue. The impact on profits is the issue. Companies seem to be afraid about how their earnings will look if options-related expenses wind up in the highlights of an earnings report instead of a footnote. However, I don't think the companies have much to fear in that regard either.

After all, Microsoft said in January that it expects its new restricted stock program will lower earnings per share by about 35 cents this year. The company's public guidance is for earnings to come in at 82 cents or 83 cents a share, including the charge.

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But analysts have simply added the 35 cents to their estimates. The consensus projection for Microsoft's earnings this year is $1.19 per share, according to First Call. So analysts would very likely treat options expenses in a similar manner.

Plus, it's not as if activist shareholders are calling for the elimination of stock options.

"Just because a company is expensing stock options doesn't mean they can't hand them out. We want to see them on the financial statement. Show us what it is costing shareholders," said Priscilla.

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