Stock Options and the Lying Liars Who Don't Want to Expense Them

The debate about whether stock options should be expensed at the time they are issued is really no debate at all. Although legitimate issues exist about how to carry out this endeavor (what model to use, what time period to expense them over, how and when to tax them), there is simply no strong argument against expensing—and very powerful arguments in its favor. This article reviews many of the arguments against expensing and the slam-dunk case for it. A great many attacks on expensing have been undertaken, but they systematically fall short of the mark, with some of them intellectually dishonest to a degree not normally observed in dialogue among serious people. The debate about whether stock options should be expensed at the time they are issued is really no debate at all. Although legitimate issues exist about how to carry out this endeavor, no strong argument exists against expensing—and very powerful arguments exist in its favor.I first review the arguments for expensing options: Options are valuable in or out of the money. They are something people want and desire. So, when a company gives them away, the company is giving away something of value, and that is called an expense. Money is involved: When options are traded on an exchange (as they are every day in large quantities), money changes hands and the prices are printed in the newspaper. So, again, issued options are an expense.After the pro-expensing review, I systematically eviscerate and ridicule the many specific arguments against expensing options when granted, including:Options have no value when issued and should be expensed only when exercised (if at all).Option values are difficult to calculate.The expense is already reported in the footnotes.Issuing options is a capital structure/balance sheet transaction, not an income statement transaction.Options are worth less than their market prices to executives because the executives are not diversified.Mandatory expensing of options will destroy technology companies.Expensing will hurt the little guy, who won't get options.Options are an expense only if and when companies repurchase shares and thus spend cash at time of exercise to prevent dilution.The effect of options should be recognized by using fully diluted shares, not by showing an expense.If companies have to move options to the top line, companies will lie about them more and analysts will “go pro forma” and ignore them.The market is efficient, so expensing does not matter because the information must be in prices already.The issue of expensing options when they are issued is one of those rare cases in an area as nuanced as financial accounting in which we have a bright line dividing right and wrong. If, ultimately, we decide not to expense employee stock options when they are granted, we will have knowingly chosen a falsehood over truth.