Firms Vest Early, Dodge Option Expense

A whopping $8 billion in expenses will never appear on income statements as 900 companies race to beat stock-option accounting deadline.
Marie LeoneSeptember 1, 2006

Dell, Sun Microsystems, CBS, and Whole Foods may have saved themselves a total of $1.5 billion in expenses this year. But they didn’t do it through cost-cutting. Instead, they did it by accelerating the vesting of stock options before a new accounting rule requires them to deduct the expense of those options from their bottom lines.

A total of 900 companies have accelerated the vesting of stock options before adopting FAS No. 123(R), erasing more than $8 billion in stock-option expenses from future income statements, estimates Bear Stearns in a report released Thursday. The number of companies accelerating options vesting increased by 151 since Bear Stearns released its January report.

Of the 900 companies that are apparently rushing to beat the expensing deadline imposed by the Financial Accounting Standards Board, 25 are under scrutiny for backdating options, including Analog Devices, BEA Systems, Juniper Networks, Jabil Circuit, and VeriSign. The 25 companies represent 22 percent of the total number of companies being questioned for their options-backdating practices.

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Under FAS 123(R), Share Based Payments, companies must expense the fair value of unvested options over the life of the instruments, starting in fiscal year 2006. By accelerating vesting schedules, however, companies are encouraging options owners to exercise options before the FASB rule takes effect, thereby avoiding the expense to income. The Bear Stearns report concludes that companies typically chose to accelerate the vesting of “underwater” options — options that are currently worthless but still must be expensed.

The companies that accelerated vesting have a median market capitalization of $251 million, and 189 have a market cap exceeding $1 billion. Of the larger companies identified in the study, 83 percent continue to grant options in 2006, although at a lower dollar amount, and 74 percent have granted restricted stock this year. In addition, 28 percent of the larger companies either have begun to grant restricted stock for the first time or provide disclosure of their restricted stock grants, says Bear Stearns.

The study authors contend that for companies that granted a similar dollar value of options and restricted stock in 2006 — compared with historical amounts — “there is a greater likelihood that option vesting acceleration was used to temporarily boost reported earnings.” If used as a temporary tactic, continues the study, “reported future earnings may need to be adjusted lower to reflect a higher normalized level of stock based compensation.” Indeed, the authors point out that “vesting acceleration, in effect, will overstate the normalized earnings power of the company.”

The top three industries accelerating the vesting of stock options are technology (33 percent), health care (17 percent), and financial (17 percent). The were no utility companies identified as accelerating stock options, and energy and telecommunications companies represented only 1 percent and 2 percent of the identified companies, respectively.

The five largest companies, by market cap, that accelerated vesting were JP Morgan Chase, Comcast, News Corp, Dell, and Corning. However, Bear Stearns also calculated which companies would gain the most through accelerating vesting; that is, the 25 companies with the largest future stock-option expense to record. Topping that list were Dell ($591 million in accelerated expenses), Sun Microsystems ($400 million), STMicroelectronics ($280 million), CBS ($263 million), and Whole Foods Market ($202 million).