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Readers' input.

STOCK OPTION

I was disappointed to see that none of the authors of the stock option accounting articles [October 2002 Strategic Finance] took the strong stand that companies should bite the bullet and record stock option compensation cost in the same fashion as the executive who receives the benefit measures its value and as the man on the street also views the value--the excess of the market price over the price the option holder pays on the day of exercise. The exercise date is the date of the final settlement of the exchange transaction between the company and the option holder. Until exercise, the company is obligated to issue stock to the individual at a set price at some time in the future, and the individual is, as pointed out in the article by Alfred M. King and Summer Parrish, required to remain in the employ of the company.

The use of a grant date approach for measurement ignores the fact that the exchange is not complete until exercise, and completion of an exchange is the normal basis for the ultimate measurement for a transaction under generally accepted accounting principles. The grant date approach also ignores the fact that stock options are a variable/contingent form of compensation. While the exercise date approach results in more volatility in reported results, that is appropriate given the substance of the transaction between the company and the option holder.

My hopes for a strong statement were initially teased by Sanjay Deshmukh, Keith M. Howe, and Carl Luft when they stated in their article that, "The difference between the share price and the exercise price represents a cost to the firm." And later in their article they stated, "...it would seem that deducting stock options would move earnings closer to a true earnings figure." However, my hopes were dashed when they ultimately conclude to rely on the efficient market to sort things out, irrespective of the financial statement treatment. Their approach basically says we don't need financial statements that fairly present. This is scary.

Frank C. Minter's article recognizes that there is an ongoing cost to stock options after their grant, but he cuts off recognition of expense at the date of vesting, even though, as I point out above, the transaction is not settled until the exercise date. Minter rightly points to Lucent in his example of why using the grant date may result in erroneous recognition of expense, but he doesn't recognize that this problem also exists with the vesting date approach that he supports. Between the vesting date and the exercise date the market may tank, or, for some other reason, the option holder chooses not to exercise. Under the vesting date approach, some amount of compensation may remain recorded on the books, while there will have been no cost to the company.

As some may ask how one would account for the cost during the period the options are outstanding under the exercise date approach, the market price of the stock at the interim period end would be used to measure the cumulative compensation expense, as described in Minter's article.

Michael P. Bohan
COPYRIGHT 2002 Institute of Management Accountants
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Copyright 2002 Gale, Cengage Learning. All rights reserved.

 
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Publication:Strategic Finance
Date:Nov 1, 2002
Words:523
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