“Your Stock Options/Stock Purchase Plans are Threatened because of 7 Bureaucrats. These 7 FASB Bureaucrats plan to enact a proposal that will eliminate broad-based stock option plans. Your security and the Valley’s security are threatened.
What sets Silicon Valley apart? Stock options. Why do we get the best people? Stock options. What’s the one incentive left? Stock options.”
- March 1, 1994 Memo on March 25th Silicon Valley Employee Stock Option Rally
The use of stock options to compensate employees was spurred in 1950 by favorable tax treatment. A typical plan was one qualified for tax purposes, whereby options were granted at no less than fair value at date of grant and exercisable in future periods. The granting corporation obtains no tax deduction, and tax to the optionee is deferred until sale of shares under option. Stock compensation plans became the mother’s milk of start-up companies, particularly high technology entities.
The Committee on Accounting Procedure first dealt with options in 1948 and revised its guidance in 1953.(30) The Accounting Principles Board updated that pronouncement in 1972 to deal with a variety of newer, more complex plans and stock compensation arrangements.(31) Generally, no cost was ascribed to options if the exercise price equaled or exceeded the stock’s market price on the date of grant. If the exercise price was less than market, compensation was measured by the excess of market over exercise price (the intrinsic value method).
The arguments for “no cost” accounting for traditional options included that dilutive effects were reflected in earnings per share, that there was no cash cost to the grantor (the marketplace, not the grantor, funded the spread and option exercises increased entity equity), and that the fair value was impracticable to measure. However, this was an anomalous exception to the concept of ascribing value to securities issued for assets or services. It complicated the analyses and comparisons of companies that used options extensively to compensate employees and those that did not. Some derided that there was “no accounting” for options and no value assigned to grants.
In the mid-1980s, the FASB began a project to resolve the hodgepodge of inconsistent guidance then existing for stock compensation. When it became evident that the Board was considering a standard that would lead to recognizing compensation expense for the value of options granted, even if the option price exceeded market at grant, it began perhaps the most controversial and stressful period in accounting standards setting.
The Board encountered unprecedented opposition even before a proposal was issued for comment. Over 500 letters poured in during deliberations, and political pressure was brought to bear after an exposure draft was issued in June 1993. The FASB was viewed as a threat to the viability of the high technology industry and thus to the national interest and was the target of Silicon Valley protest rallies and outrage from some members of Congress. The six largest accounting firms sent a joint letter expressing concerns over recognition. While legislative proposals directing the SEC to reject the FASB’s efforts were not successful, the Senate passed a nearly unanimous resolution urging the FASB not to proceed.
SEC Chairman Arthur Levitt had supported the FASB, but advised the Board not to jeopardize its future by issuing a standard that would require the expensing of options. In light of the hostility from Congress and Levitt’s counsel, the FASB backed away and issued a standard that required disclosure, but not income statement recognition, of the expense associated with stock options.(32) Disclosed expense was based on the fair-value method, as opposed to the prior intrinsic method. The FASB encouraged entities to report the expense in earnings, and a few did.
Chairman Levitt later would rue his pushing the FASB to surrender. Believing he was acting in the Board’s best interests, he feared that he may have opened the door to more meddling by Congress.
Almost a decade later, the FASB revised option accounting, finally requiring the recognition of compensation based on the grant-date fair value of the award.(33) The environment had become more favorable following financial frauds that led to Sarbanes-Oxley, as several companies voluntarily adopted expense recognition to enhance credibility of reporting. The SEC provided unwavering support this time, despite legislation proposed in the House that effectively would have blocked the standard’s issuance.(34) The Board collaborated with the International Accounting Standards Board and its related stock compensation project, resulting in increased convergence with international standards.
(30) January 1953 ARB No. 37 (Revised), Accounting for Compensation Involved in Stock Option and Stock Purchase Plans.
(31) October 1972 APB Opinion No. 25, Accounting for Stock Issued to Employees.
(32) October 1995 SFAS No. 123, Accounting for Stock-Based Compensation.
(33) December 2004 SFAS No. 123 (Revised), Share-Based Payment.
(34) H.R. 3574 (108th) Stock Option Accounting Reform Act.
