Citizen Works

Stock options
Legislative Overview

When stock options came to prominence in the early '90s, they were seen as an effective tool to align management's interest with the shareholders' interest. The more executives had vested in the stock, the logic went, the more focus they would put on share price. And not only were stock options tax deductible, they were also free (since, under current accounting rules, it costs the company almost nothing to print up more shares and issuing stock options does not count as an expense on the balance sheet).

But stock options never quite worked the way they were supposed to. Executives, given options by the boatload, did everything they could to pump up the stock price by increasing profits, but often at the expense of long-term growth. And knowing that the profits were unsustainable, the executives sold their options in a timely fashion, leaving the shareholders to suffer the inevitable tumble.

The question of the day in Congress, however, is not whether to ban stock options. It is merely whether or not to require companies to count them as expenses in their financial statements.

Those in favor of expensing options (most prominently Sens. John McCain (R-AZ) and Carl Levin (D-MI)) recognize that options are not free. Giving stock options to executives means that the company is missing the chance to sell that option on the open market, essentially losing out on profit. Issuing stock options also dilutes shareholder value, since each stock certificate pays less of a dividend if there are more stock certificates. Expensing advocates also point out the double standard: how can options be tax-deductible if are they not an expense?

Those against expensing options (most prominently Sen. Joe Lieberman (D-CT)), claim that expensing stock options is an exercise in futility because options have no value until they are actually cashed in. The business lobby argues that expensing stock options will take away an important tool to fund start-ups. For example, many tech companies pay employees primarily in stock options (since the companies are not making real money). But in reality, the vast majority (about three-quarters) of stock options go to top executives, which typically receive more than half of their pay in options.

Sens. McCain and Levin fought hard to get an amendment on expensing stock options into the Sarbanes-Oxley Act, but neither party was interested, not even in calling for the Federal Accounting Standards Board (FASB) to study the issue. (FASB is now doing so anyway on its own). Sen. Majority Leader Tom Daschle (D-SD) has said he may consider the issue in the fall.

McCain and Levin introduced a bill back in February, S. 1940, that would have required companies that want a tax deduction for options to expense options. It was quickly killed by the business lobby. Rep. Pete Stark (D-CA) introduced an identical bill in the House (H.R. 4075) back in March. That bill has not seen any action either.

Other, more mild fixes on stock options abuse have since emerged.

Lieberman has introduced a bill, S. 2877, that would require half of the stock options to go to employees earning less than $90,000 and call on the Securities and Exchange Commission (SEC) to require shareholders to approve all stock options and to recommend rules for requiring executives to hold stock options for the long term.

Sen. Ron Wyden (D-OR) has introduced S. 2822, which also calls on the SEC to issue rules requiring shareholder approval of stock options and issue specific rules to require executives to hold options for the long term.

The mildest Senate proposal comes from Mike Enzi (R-WY). His bill, S. 2760, merely calls on the SEC to make recommendations on expensing stock options.

None of the three bills actually calls for expensing options.

In the House, two proposals besides Stark's have been introduced.

H.R. 5147: Introduced by Mary Bono (R-CA), it calls on FASB to develop standards (which FASB is already doing)
H.R. 5242: Introduced by Rep. Amo Houghton (R-NY), it calls for added tax breaks to encourage more stock options.

Only time will tell whether the advocates of options expensing, which include such economic luminaries as Alan Greenspan and Warren Buffet, will win out over the powerful Washington business lobby.

But a move toward expensing is beginning regardless. By the end of August, about 75 companies had voluntarily agreed to expense options, including Wal-Mart, General Electric, General Motors, Citigroup, and Amazon.com, and even SEC chairman Harvey Pitt was quoted as saying that the expensing of options was inevitable.