Dennis Beresford is having flashbacks these days, and they are anything but pleasant. Congress is once again trying to derail the Financial Accounting Standards Board's efforts to require companies to expense stock options. And for the former FASB chairman, the lawmakers' moves are a painful reminder of what happened during his tenure at the board's helm nearly a decade ago. "It's déjà vu all over again," says Beresford, now a professor of accounting at the University of Georgia.
Under intense pressure from Capitol Hill, FASB under Beresford backed off of a similar proposal in 1994, compromising not only the board's position on expensing but its very independence as a standard setter. It took years for the board to buck congressional pressure again, this time on new, far-reaching rules on derivatives and business combinations. Of course, FASB's submission to Congress did nothing to prevent lawmakers from scolding the board for the cautious pace of its its deliberations on accounting issues related to the Enron scandal.
No one in Washington, D.C., claims to desire an end to the independent setting of accounting rules, at least in public. The legislators insist they are merely trying to aid the struggling economy by encouraging greater use of entrepreneurial incentives.
But will keeping stock options off the income statement have the desired effect? Many observers contend that while FASB's 1994 decision not to require options expensing may have inspired entrepreneurs, it also certainly motivated executives to pump up their companies' stock prices by whatever means necessary. In fact, the widespread use of nonexpensed stock options is generally thought to have led not to economic strength, but to inflated stock-market valuations, excessive executive compensation, accounting frauds, bankruptcies, and the loss of approximately $5 trillion.
Some managers may welcome congressional efforts to reinflate the stock- market bubble, but forcing FASB to back down on options could instead undermine whatever confidence in the financial markets investors have since regained. "The capital markets need high-quality, unbiased information to make allocation and pricing decisions," says FASB board member G. Michael Crooch. "Managing accounting data for some hoped-for economic result is too risky and dangerous."
A Simple Bill
The current fight is still in its early stages. Until recently, in fact, the latest debate over expensing was limited to arcane issues involving valuation methodology. But now Congress has reentered the picture, and its legislative steps would render the outcome of the debate about valuation methods all but moot.
At first glance, the bill introduced in March by Rep. David Dreier (R-Calif.) and co-sponsored by Rep. Anna G. Eshoo (D-Calif.) — H.R. 1372, or the Broad-based Stock Option Plan Transparency Act of 2003 — sounds innocuous enough, calling as it does for enhanced disclosure of stock-option plans.
But the bill, which has attracted considerable bipartisan support, including that of half the Democratic presidential hopefuls, first demands a three-year study by the Securities and Exchange Commission to assess the potential impact of broad-based stock-option plans on the economy.
Meanwhile, the legislation would impose a moratorium on new FASB rules related to stock options, so if the board went ahead and mandated expensing anyway, the SEC would be barred from recognizing the rule as part of generally accepted accounting principles (GAAP).
So much for independently set accounting standards.
Back to the Future
In the face of similar pressure nine years ago, FASB's retreat enabled it to live to fight another day. But board members and others involved in that decision now regret the move. Former SEC chairman Arthur Levitt admits that urging FASB to back off was "the biggest mistake I made" during his eight-year tenure.
The International Accounting Standards Board (IASB), FASB's international counterpart, is clearly concerned about the impact the bill could have on accounting standards in general. "If the U.S. Congress or political authorities in other countries seek to override the decisions of the competent professional standard setters...accounting standards will inevitably lose consistency, coherence, and credibility," warned Paul A. Volcker, former Federal Reserve Board chairman and current chairman of the foundation that oversees the IASB, in written testimony.
But Eshoo and Dreier represent districts in California where incentive stock options are still sacrosanct. And to be sure, high-tech companies, many in their early stages and strapped for cash, rely on stock options as incentives for employees as well as for executives. According to these lawmakers, expensing would hobble the ability of such start-ups to attract talent and, in turn, stifle innovation in the U.S. economy. "This is a public-policy issue," said Dreier in his testimony at the hearing in June. "This is not an accounting issue."
Yet it's hard to see how accounting is not public policy when the public relies on financial statements prepared under U.S. GAAP to determine whether companies deserve its capital. In FASB's view, options should be included in the income statement like other forms of compensation expense, because that would give shareholders a more honest picture of a company's finances than burying the impact of options in the footnotes. Investors applaud the stance. "If the result of having [option-based pay] expensed means you do away with the plans," says Peter Clapman, senior vice president and chief counsel of corporate governance at TIAA-CREF, "it means that it was never a particularly good form of compensation in the first place, because it shouldn't depend on accounting treatment."
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