17 January 2005
In the aftermath of accounting scandals in the United States involving companies like Enron and WorldCom several years ago, regulators and financial industry experts initiated a thorough review of regulations that affected corporate transparency and governance. The impact of the scandals were so far-reaching that many other countries and accounting bodies other than those in the US carried out their own reviews.
One of the widely-discussed recommendations was that regarding the change to the accounting rule on the treatment of stock options. It was felt that the issuance of stock options by a company to its management encouraged the latter to hoard cash and, in the absence of proper accounting of its dilutive effect on the holdings of the other shareholders, masks the costs incurred by the latter.
On 16 December 2004, the Financial Accounting Standards Board in the US published a rule that states that, starting June 15, US companies will be required to expense stock options. Some US companies, especially in the technology sector, are reported to be unhappy about this ruling, which they claim hampers their ability to issue stock options to attract talent.
However, opponents of the rule still have time to lobby Congress and the Securities and Exchange Commission, both of which could override it. The Republican victory at the November election last year in particular opens up the possibility that Congress will overturn the rule, as some of the newly-elected Republicans are said to support diluting the expensing rule.
In contrast, a similar ruling is already in effect in Singapore. Not surprisingly, it is creating similar unhappiness in Singapore.
In a report in The Business Times entitled "Options expensing forces rethink on staff rewards" on 12 January, Michelle Quah wrote that "corporate compensation in Singapore is changing with the new year, as a new accounting rule compels companies to expense their stock options".
The new rule that she refers to is called FRS 102, which stipulates that from 1 January this year, listed companies must expense their stock options, measured at fair value.
According to Quah, this new rule "has changed the way the compensation game is played". Some companies are moving away from stock options towards performance-based share plans, she said, "because they realise they will have to account for these options as an expense from this year".
Stock option expensing is, of course, just an accounting change. It does not change the fundamentals of the company. The question is: Why should a mere accounting change affect the way a company compensates employees?
One possible answer is that accounting for stock option expenses is difficult -- there is no standard way of accurately assigning the cost of a stock option. Then again, there are plenty of accounting rules for which there is no standard and accurate way of complying. Companies have always found a way to live with them.
The more sinister interpretation is that the rule is having its intended effect. Managements who had been using stock options to pad profits and present a pretty face to investors can no longer do so. Thus, there is no longer any point in using them.
Determined managements, of course, can still find other creative ways to hide compensation expenses -- or any expenses for that matter. Those who have nothing to hide, though, will see less need to change compensation practices. For examples, according to Quah, Keppel Corp and CapitaLand have both decided to continue with the use of share options.
Ultimately, stock option expensing is just another part of the moves to improve the transparency of management action. A management that acts in the true interests of the company and its investors should have nothing to hide and therefore should have no fear of stock option expensing.
Disclaimer: The commentaries posted here represent the opinions of the author at the time of posting and should not be taken as investment advice. Readers who wish to take any investment action based on information obtained from this site should seek appropriate advice from a qualified financial adviser.