ACCOUNTING FOR STOCK OPTIONS   Term Paper ID:34828 Click to get this paper

Essay Subject: Discusses employee stock option programs and FASB accounting requrements including recent changes that now ...... More...

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Paper Abstract: Discusses employee stock option programs and FASB (Financial Accounting Standards Board) accounting requrements, including recent changes that now treat options as expenses. The use of stock options as a reward for employees and executives. Paper Introduction: Accounting for Stock Options Introduction For many years stock options provided companies with a key tool usedto reward employees and executives Beginning in the s stock optionsbecame an increasingly popular way for companies to tie corporateperformance to compensation for chief executives and key managers Thistrend reached its peak in the s but with scandals at Enron and othercompanies stock options have come under increased scrutiny Over the pasthalf century the professional manager has emerged as the chief executivein many large firms Unlike Text of the Paper: The entire text of the paper is shown below. However, the text is somewhat scrambled. We want to give you as much information as we possibly can about our papers and essays, but we cannot give them away for free. In the text below you will find that while disordered, many of the phrases are essentially intact. From this text you will be able to get a solid sense of the writing style, the concepts addressed, and the sources used in the research paper. Reload options become increasingly common during the 198 s and 199 sas ways of providing stock options. Beginning in the 198 s, stock optionsbecame an increasingly popular way for companies to tie corporateperformance to compensation for chief executives and key managers. Under thisexercise, the executive exercises the option and immediately sells, at themarket price, the number of shares necessary to pay for the exercise. Conclusion Stock options provide a way for companies to reward top performers,whether technical individuals or executives responsible for the strategicdirection of the organization. "Will Stock Options Lose Their Sex Appeal?" Business Week (Jul 21, 2 3): 23.Homer, Julia. Lastly, the executive can choose not to exercise theoption until some future date. Thistrend reached its peak in the 199 s, but with scandals at Enron and othercompanies, stock options have come under increased scrutiny. Although Congresshad criticized the FASB for not taking a stronger stance earlier, expensingoptions is still not a popular tactic. Traditional Stock Option Accounting Until late 2 3, equity-compensation programs (so-called because thestock represents an equity position in the company) require that proxydisclosures be made to shareholders, that accounting charges beappropriately documented, and that the tax ramifications be clearlyunderstood and balanced with the need to reward executives for creatingshareholder wealth. Premium price stock options have a higher exercise price than themarket price when the option is granted. (Restrictedstock is that which cannot be sold at full profit to the holder.) Usingthis method encourages executives to hold the stock rather than selling itimmediately (Martin 23). Employee Stock Option Programs Stock options are essentially the right to purchase stock at somespecified date in the future at an agreed-upon price. Yet, the 1994 decision not to require companies toexpense their options indicates that the group is subject to influence.Most recently, Congress has already moved to subvert the FASB's decision torequire expensing. Some have warned that such a movewill result in high-technology companies being unable to raise sufficientfunding if stock options--used to attract high-powered talent--becomeexpenses and the companies cannot show profits as a result. Of course, the CEO doesnot directly control the trading price of the stock, but stock options arebased on the assumption that the market will drive up the price of stocksof companies that are doing well (Greene 23). Thus, the "insider" holdings of companies are watched carefully, andthe broader market, particularly large investors, also carefully considersthe transactions conducted by insiders. Financial Management, 2 (Win 1991): 91-1 .Dever, Raymond L. "Expensing Options Inexpensively." Business Week (Dec 8, 2 3): 12.Long, Michael S. If the executive holds the restricted stock for a specificperiod of time, the stock eventually becomes unrestricted. This price is notrelated to the price the stock is being traded at either at the time ofgranting or the time of exercise. "Who Rules Accounting?" CFO, The Magazine for Senior Financial Executives, 19 (Aug 2 3): 34-39.Toloken, Steve. "Stock Option Fundamentals." Employee Relations Law Journal, 26 (Aut 2 2): 115-13 .Schneider, Craig. While companies statedthat options were granted to increase the manager's interest in the companyand thus serve as a strong incentive for better performance, the tax issuewas considered to be a prime motivator, as well (Conte & Kruse 92). Other companies have opted to use other forms of remunerationbesides options in order to provide incentive to their executives and otherkey staff members. The restricted stock kicker program gives the executive restrictedstock when the option is exercised. In 2 3, the issue again became key in the wake of the Enronscandal, and the FASB is moving forward with the expensing requirement.Companies have brought pressure to bear on their government representativesto forestall having to comply with the new requirement, noting thesignificant impact such restating would have on the companies' bottomlines. Accounting for Stock Options Introduction For many years, stock options provided companies with a key tool usedto reward employees and executives. "How to Avoid Negative Votes on Pay Plans." Directors & Boards, 15 (Spr 1991): 43-45.Batt, Tony. Corporations." Financial Management, 21 (Aut 1992): 12-21.Martin, Donald D. Works CitedAisenbrey, Beverly W. Over the pasthalf century, the professional manager has emerged as the chief executivein many large firms. "The Incentives Behind the Adoption of Executive Stock Option Plans in U. The concern of business is thatexpensing options results in a significant decrease in income--on paper--and that the result can be that companies no longer are able to post aslarge of profits as they have in the past, or--in the case of new companies--there may be no profit realized. Typically, however, most executives choose to exercise their optionsand hold the stock, or defer the exercising of the options to a later date. In the above example, the CEO mayexercise the option of the $15 shares and purchase 1, shares of stock.Later, the CEO may be granted a new option at $2 per share, but this timefor 1,5 shares. Such companies often grant stock options to attracthighly qualified technical individuals. Initially, the FASB proposed at that timethat companies expense options, but under pressure from Congress, the FASBonly implemented the disclosure requirement. The FASB is anindependent association that is supposedly free of interference from otherentities. Under these rules--implemented in 1994--the FinancialAccounting Standards Board (FASB) required that companies provide pro formaaccounting statements only in annual statements showing the effect of stockoptions. Once an option has been granted to an executive, there are threealternatives that the executive can follow. Another way in which stock options can be exercised so that theexecutive does not have to use his own funds but can still retain some ofthe option is through the "immaculate exercise" (Zesk 8 ). If the price does notmove to the $15 level, the CEO does not benefit (and may well be dismissedfrom the company). Recent Restructuring of Stock Option Accounting After the Enron scandal, in which the company's actual financialperformance was not accurately reflected in its financial statements, thepublic expected some type of action to be taken in order to prevent suchproblems in the future. "Unusual Stock Grants Reward Performance." Plastics News, (Aug 24, 1998): 27.Zesk, Thomas J. Thus, theissues at stake have significant financial consequences (Lavelle 12). Sinceinstitutions control such large blocs of stock, their actions can haveconsiderable effect on stock prices, and if they leave a stock that isperforming badly while executives are receiving high levels of pay throughstock options, the price of the stock may drop. As an example, Cisco Systems granted 199million stock options in 2 3. Certainly Enron, with itsoff-the-books partnerships that provided shareholders with an inaccuratepicture of the company's actual financial situation is a prime example ofthis (Dever 8). The income tax effect of stock options is one of the areas that havegained much attention as the popularity of options has increased. "Exercising Stock Options Without Cash: A Survey of What's Available." The CPA Journal, 6 (Apr 199 ): 8 -81. If the FASBrules were used, more than $1.1 billion would be expensed. Shareholders of record often favor this strategy at thetime the option is granted since it ensures that their own positions willimprove before the CEO receives additional compensation (Toloken 27). Typically, compensation programs that involve stock options arepresented to shareholders for approval. This most recent move by the FASB has also brought into focus therelationship between the FASB, the SEC and Congress. "How Did We Get Here?" CFO, The Magazine for Senior Financial Executives, 18 (Oct 2 2): 4 -43.Lavelle, Louis. This researchexamines stock options, recent events at the FASB that have changed howcompanies account for their options, and the consequences of those changesto the business and investment community. The use of stock options is usuallyreserved for decision makers in the company, with lower-level employeesoffered stock purchase programs (if any stock benefit). Since1917, the maximum marginal personal tax rate rose to 25 percent in the late192 s, but increased to 91 percent in the post-World War II period (Long12). Either of these strategies, however, runs the risk that the executive willhave a significant percentage of company stock--or options, which caneasily be converted to stock--in their personal investment portfolios.While potential investors and shareholders consider such a bias favorable,the executive is likely to seek a more balanced portfolio structure. Under these programs, the executiveuses old shares to exercise new options. These are new options, consistent withthe remaining term of an original option, for the number of remainingshares used to exercise a grant. Sincethe CEO is primarily responsible for the direction of the company over thefive-year period, the incentive is for the CEO to maximize the company'sperformance in order to increase the stock price. One, which wouldhave eliminated the requirement for all companies was put aside in favor ofanother, now making its way through the legislative process, that wouldrequire only that companies report options to the top five executives (Battn.p.). Issuing stock options to chief executives was one way to minimizetaxation since the profits from stock options were considered capitalgains, taxed at a lower rate than regular income. According to some analysts,these disclosures essentially recorded the stock options "off the books"("Latest Stock" 22). For example, a stock option might begiven to a CEO that allows the CEO to purchase 1, shares at $15 pershare at any time during the next five years. "How Small Business Can Gain Advantages from ESOPs." National Public Accountant, 39 (Feb 1994): 22-27.Moran, Anne E. Bickford. As a result, the incentive to avoid excessive taxation increased, aswell. In this way, 4 shares are retained and the executive has had to use none of his own funds. If the market price is above$15, the CEO makes a profit by purchasing the 1, shares, and thenselling them; if the market price is below $15, the CEO does not. For these reasons, someinstitutions showed concerned with using their influence to improve theperformance of the stock while working to change the compensation structureof the executives. The difference between reporting all employee options and only the topfive can be significant, particularly when considering the effect on high-technology companies. In this way, the executive is able to avoid usingpersonal funds to exercise the option, leaving those funds available forother investments. This issue is not likely to disappear soon, and with the largefinancial impact it will have on the business and investment communities,additional changes and modifications can be expected. The executive can exercise theoption and sell the shares. and Lawrence C. In the example above, the CEO wouldreceive 1, shares of restricted stock at $15 per share when the optionwas exercised. Or, the executive can exercise the option andhold the shares. "Tell the Truth, Unless it Hurts." The CPA Journal, 73 (Sep 2 3): 8-9.Greene, Jay. Unlike the firm's original founders, these executivesoften own only a very small percentage of the company's outstanding stock.This can create the potential for a conflict of interest between theexecutives maximizing their own individual benefit and the outside ownerswanting the company's value maximized. It is the active participation by institutions that aredisappointed in company performance that brought about the use of thepremium stock option program, in which the option price is higher than thecurrent market price of the stock. This makes it difficult to attract newinvestors, and also increases the likelihood that the stock price itselfwill fall given the poor performance on the financial statements (Dever 9). During the198 s, however, institutional investors took increased interest to suchstock option programs, particularly when executive pay through stockoptions increased at a time when overall company performance was down.Institutional investors are the large investors, such as pension plans,which generally represent the greatest bloc of shareholders. Others areconcerned that such a requirement implemented without a phase-in periodwill eliminate the equity of companies simply because of expenses thatmight never come due--if the executives do not exercise the options, thereis no expense (Schneider 35). A variation on this strategy can also be used toaccumulate additional shares in the company without using personal funds.Under this scenario, the executive sells only the number of shares requiredto finance exercising the new options (Aisenbrey & Bickford 44). This type of option helps executivesfinance the exercise of a stock option (Moran 118). If theprice moves to more than $15 per share during the five-year period, theexecutive benefits and the incentive has worked. It was also increased pressure byinstitutional investors, as well as the junk bond scandals of the 198 s,that brought the SEC and FASB to investigate changing the way thatcompanies reported their stock options to shareholders in the early 199 s(Homer 43). The CEO may elect to exercise the option by selling hiscurrent holdings. Only six million of those went to the topfive earnings at the company. Using the previous example, themarket price might be $1 per share at the time that the CEO is granted theoption to purchase at $15 per share. Several different bills were introduced in the Senatethat would reduce or eliminate the expensing of options. When executives own stock in the companies by which they are employed,the general view is that executives have a stake in the stock performingwell. Since 1973, the associations standards have been recognized byboth the Securities and Exchange Commission (SEC) and the AmericanInstitute of Certified Public Accountants as the guidelines that are to befollowed by companies. However, the junk bond scandalsand the recent Enron scandals also demonstrate that executives can bemotivated not only to take all appropriate steps to ensure that companiesperform well so that their stock goes up, but to create the appearance ofwell-being so that the stock increases in value. Over the years, a number of differentstrategies have been developed for structuring the plans so that the taxconsequences to individuals exercising the options are minimized, andoptions have made a number of executives--and employees--quite rich. When the FASB announced in 1994 that it was investigating requiringcompanies to expense their options, there was significant resistance fromthe business community; that resistance took the form of Congressionalpressure that led the FASB to back down from the expensing option andchoose instead the disclosure requirement. The executive thus needs $15, to exercise the option.If the current market price is $25 per share, the executive can immediatelysell 6 shares ($15, / $25) to finance the exercise. Some well-publicized transactions have occurred when an executiveimmediately exercises and sells options, but such transactions tend tocause concern in the investment community. The FASB once again returned to the issue of howstock options are accounted for in business, and this time opted tointroduce the requirement that such options be expensed. Inthe example above, the executive has an option to purchase 1, shares at$15 per share. "ESOPs and Profit-Sharing Plans: Do They Link Employee Pay to Company Performance? Since institutions control a largenumber of shares, they are able to veto programs that do not meet withtheir approval. If the Congressional proposal were used tocalculate the options, only $14.5 million would be expensed. Because stock option programs can be highly favorable to theirparticipants, chief executives understandably favor them. S. However, these statements were presented as part of the company's"official" financial statements. This strategy encourages the CEO totake the actions that maximize the shareholder value since that is the onlyway that the CEO will realize any benefit to the stock option. These staffers may not beconsidered executives, but there are nonetheless key employees and theirstock options can be significant. Several different scandals have brought to light the importance ofaccurately reflecting the potential impact of stock options on companies.The FASB considered requiring companies to expense options as early as1994, but retreated from that stance, requiring only disclosures ofoptions. To avoid overweighing theirportfolios with company stock, yet to demonstrate to stockholders that theyhave a personal interest in the company, some executives have worked withcompensation committees to create stock-for-stock exercise programs inorder to exercise new stock options. "Stock Options Not an Expense Under Legislation Supported by Nevada Senators." Las Vegas Review-Journal (Nov 2 , 2 3): n.p.Conte, Michael A., & Douglas Kruse. If this paper is not what you are looking for, you can search again: Search for: or Click here to request an essay written just for you.

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