Accounting & Tax

Global Accounting Body Out Of Gate And Into “Buzz Saw”

For its first order of business, the newly minted International Accounting Standards Board takes on accounting of employee stock options.
CFO.com StaffAugust 27, 2001

In drawing back the curtain on its initial agenda, the newly appointed International Accounting Standards Board recently let the world know it’s taking up the accounting treatment of employee stock options.

It’s an issue that in the 1990s sparked such heated controversy that it almost led to the extinction of the US’s Financial Accounting Standards Board, according to a report by Dow JOnes Newswires.

No one can say with certainty what direction the IASB will ultimately take in a process that’s expected to last many months. But given the predilection of some of its members, says Dow Jones, observers believe there’s a good chance the group will recommend exactly what the FASB tried to force on U.S. companies and failed: recognizing the fair value of employee stock options as a financial expense.

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Veterans of the U.S. stock option ground war are already raising questions about why the IASB is rushing out of the gate with such a highly contentious agenda item, especially at a time when it needs to establish diplomatic credentials, says Dow Jones. The IASB’s goal is to reach a consensus that will lead to convergence on international standards.

“They have chosen to walk into a buzz saw, basically,” Brian Borders, president of the Association of Publicly Traded Companies, a staunch critic of fair value stock option expensing, told Dow Jones. “We have to recognize, as FASB did after its stock-option proposal, highly controversial issues like this don’t do these organizations any good.”

In recent years, Corporate America, particularly technology companies, increasingly relied on stock option grants as a cheap way to enhance pay packages. It was in that vein in the early 1990s, that companies and their advocates successfully fought off FASB’s effort, which would have led to stock options taking a big bite out of the bottom line.

Eventually, with corporate allies in Congress threatening FASB’s existence if it went through with its plan, the board retreated and instead gave companies a choice, either expense the fair value of stock options or disclose the theoretical value in footnotes. Virtually all public companies have chosen the latter, compensation experts say.

IASB members and staffers say it’s too early to predict the final outcome, for which there is no definitive timetable. Project manager Kimberly Crook noted to Dow Jones, however, that several of its members, including Chairman Sir David Tweedie, already expressed support for recognizing stock options in financial statements in a paper published last year. The controversial “discussion” paper was produced by senior staffers and board members from standard-setting bodies of Australia, Canada, New Zealand, the UK and the U.S., known as the G4+1 working group.

Individual nations are currently under no obligation to follow the group’s recommendations. But the European Commission has proposed that by 2005 all listed companies in the European Union be using international accounting standards, and eventually a legal mechanism will be set up for potential adoption of the IASB standards, Crook told Dow Jones.

Number-crunching purists widely believe that reflecting the value of stock option grants as a cost is the only correct and transparent accounting treatment, and FASB insiders hang onto that belief, including chairman Edmund Jenkins. But Jenkins is hardly endorsing a rush to reopen those barely-healed wounds, says Dow Jones.

FASB “strongly supports” working with the IASB to achieve convergence, Jenkins told the news service. “We think we have one global capital market, and investors and companies both deserve to have a single set of reporting standards they have to deal with.”

The board, however, is not in a position to consider whether or not it would tackle the subject of stock options again, he said, stressing there is no urgent need to place the topic on its agenda.

“There are no plans to undertake any kind of project right now,” he told Dow Jones. “We couldn’t say what direction we would go in until we see what direction they are headed. It’s not something we would just adopt the next day after IASB completes any work.”

With the current rules in place, the U.S. already has gone further than other countries in setting accounting rules for stock options, he said, noting, for example, recent strictures on repricing, or the lowering of the strike price on out-of-the-money options.

That said, Jim Leisenring, IASB’s outspoken U.S. member and FASB liaison who until April was director of international activities at the U.S. board, said he understands why critics of option expense accounting are worried, because the group’s goal is not to “harmonize with the lead singer,” but to converge on “superior” accounting methods, according to Dow Jones.

Even Leisenring, a staunch supporter of such treatment who also took part in the G4+1 paper, recognized the political trouble the group would be asking for if it brought the issue up as a potential agenda item.

“I said it’s not worth the political fight to do this,” the former FASB vice-chair told Dow Jones. “Can we improve financial reporting in the world by addressing the issue? The answer is ‘yes.’ Did I advocate putting on the agenda? The answer is ‘no.’ I wouldn’t have done it first thing, at least.”

Even in these early days, critics of stock option accounting are already beginning to mobilize. Borders, of the Association of Publicly Traded Companies, has heard from a British corporate counterpart looking to form an alliance as the IASB proceeds with its work.

Sure to weigh in on the other side are U.S. supporters of expense accounting for stock options, including TIAA-CREF, the influential teachers’ pension fund. For one thing, TIAA-CREF executives say, existing rules allow a disconnect between the cost to shareholders through dilution of their holdings, and what is essentially a freebie for companies, says Dow Jones.

Moreover, because companies can dole out standard fixed-priced options with no bottom-line impact, there’s a disincentive for companies to grant options that require executives to beat stock indexes, which have less favorable accounting treatment, Ken Bertsch, TIAA-CREF’s director of corporate governance, explained to Dow Jones.

Because the giant fund invests heavily internationally, it believes strong international standards would be beneficial, as would comparable nation-to-nation financial statements. Any roadblocks in that quest could have broader implications.

“If they create a good standard and it’s controversial and shot down in the U.S., that would be very unfortunate,” he told Dow Jones. “The U.S. is in a sensitive place in all of this. They are seen as, on the one hand having strong standards, but also being excessively chauvinistic and parochial. If the U.S. is an obstruction here, that’s really going to have some very negative effects.”