Out of Options

Why some cowardly companies still won’t count stock options as expenses.

Shareholders of software company PeopleSoft yesterday voted to recommend that management declare a loss instead of a profit. That’s because some 53 percent of the votes cast in its annual shareholders elections favored a proposal to treat stock options as an expense. Doing so, as the Wall Street Journal reported, would have had the effect of turning the company’s 2003 profit of $85 million into a loss of $75.5 million.

At Hewlett-Packard, shareholders in mid-March approved a similar options-expensing proposal, which would have slashed the company’s impressive 2003 profit of $2.5 billion to a somewhat less impressive $1.8 billion.

Have investors at major technology companies suddenly been seized by a fit of irrationality? Of course not. Next week, the Financial Accounting Standards Board is expected to release a final draft of rules that would mandate companies report stock options as expenses. And investors at HP and PeopleSoft have simply suggested to their managements that they comply sooner rather than later.

These votes—and management’s cagey efforts to ignore them—throw into almost comic relief the increasingly desperate efforts of technology executives to ward off the apparently inevitable mandate that they actually treat a huge component of executive compensation as an expense. In advance of the FASB’s new proposal, the International Employee Stock Options Coalition is mounting one last lobbying push, hoping it can convince Congress to put the kibosh on the options-expensing drive—as it did in the 1990s. Of course, the IESOC isn’t a grass-roots organization of programmers and Web designers with visions of options millions dancing in their heads. Its membership consists largely of trade groups that generally represent the interests of employers, not employees.

This Coalition of the Shilling’s appeals are likely to fail in Washington, partly because it’s an election year and partly because the memories of stock option excesses are still vivid. But they’ll fail mostly because the much-warned-of dire consequences of expensing options have failed to materialize.

In the past two years, market pressures—as much as the threat of regulation—have pushed many companies to voluntarily treat options as an expense. Investors have digested this significant shift calmly. Rather than punish stocks that reduce their reported income by expensing options, investors have rewarded them. According to the Financial Times, some 500 U.S. public companies have switched to expensing options in recent years. And the Wall Street Journal has reported that “companies representing 38 percent of the index’s market capitalization are expensing stock options.” Plainly, the movement toward expensing options—which has the inevitable effect of tamping down earnings—has not stood in the way of significant rallies in the S&P 500 or the Nasdaq, which are now heavily populated by options-expensers.

Indeed, the evidence suggests that companies that voluntarily slash their earnings by expensing options will be hailed rather than condemned by investors. The giant computer services company EDS yesterday told the Financial Times it was dropping out of the IESOC—and its stock is up today.

For that reason alone, you’d think that the management at HP and PeopleSoft would follow the wishes of their shareholders. But they’re not. The votes at HP and PeopleSoft were not binding—which means management is free to ignore the issue for several more months. PeopleSoft pledged its board would “give this stockholder vote careful consideration as part of their evaluation of the accounting treatment of option grants.” An HP spokesman pledged that the company would “continue to carefully debate the matter.”

Management always swears maximum fealty to majority shareholder rule—except when the votes go against their wishes. Were a majority of shareholders to vote for a nonbinding proposal that would, say, mandate the purchase of a new Gulfstream V jet, you can be sure the bosses would be doing a lot more than studying and debating it.