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Why Expense Options?

Does expensing options make sense? Mike Coke, CFO at AMB Property, says yes.
Marie LeoneAugust 26, 2002

On July 8, the management of San Francisco-based AMB Property Corp. made a surprising announcement: AMB would become one of the first companies in the nation to voluntarily expense stock options on its income statement. The move, which was triggered in part by investor worries about corporate accounting, is a departure from the more typical disclosure that appears in the footnotes of financial statements.

In the days following the announcement, several well-known companies indicated that they too would start expensing employee stock options. The list includes Coca-Cola, The Washington Post, BankOne, AIG, and Amazon.com. Some technology companies, such as Cisco Systems and Microsoft, have indicated they will not expense options, however. (You can see how AMB measures up against some of the other companies on the list with the CFO PeerMetrix interactive scorecards.)

CFO.com recently talked with Michael A. Coke, CFO of AMB Property, about the decision to expense the fair value of options granted by the company. Coke, a CPA, took the reins as CFO in January 1999.

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1:Why wasn’t AMB expensing stock options, and what made you decide to change that policy?

Mike Coke, CFO, AMB Property: When we went public in 1997, it wasn’t really a management choice. We just did what every other company in the world was doing. We were adhering to FAS 123 requirements.

Why the change? First, it was the right thing to do. During the last six or seven years, accounting rules became so specific — based on volumes of rule interpretations — that companies saw it as an opportunity to operate right at the edge of the rules. But accounting should be based on principles, not rules. In other words, there should be more “what should be done” and less “what is allowed to be done.”

Second, we had to switch accountants. Our accountant was Arthur Andersen, and although we had a great relationship with them, we had to make the switch [after the Enron debacle]. We chose PricewaterhouseCoopers, and during their initial review of our accounting policies, management brought up the idea of expensing stock options.

2. AMB’s management team, not the auditors, came up with the idea?

Coke: Yes. Last year, management was reviewing stock option policies and there was one thing we found hard to reconcile: We all viewed stock options as compensation. We all trade cash dollars of bonus for stock options. So, how is it that I personally view options as compensation, yet the company doesn’t book and record them as compensation? When we went public, we really tried to set good governance standards, so we thought expensing options was one more way of demonstrating that.

3. What kind of earnings hit did expensing the options create?

Coke: The full effect is about 5 cents a share over the next few years–not insignificant. The quirky thing about expensing options is the way you implement FAS 123. You don’t do it as an accounting change; instead it is adopted prospectively. You go from the impact of a penny reduction of net income per share this year, to two cents next year, and then four and five cents in the next few years.

4. How did stockholders react to management’s decision to expense stock options?

Coke: I don’t think it changed anybody’s view of our company. We received a lot of positive feedback from institutional investors. What I find interesting about this whole debate is the belief that all of a sudden companies are revealing their true value. We’ve been exposing these numbers all along in footnotes. I don’t think investors are fooled by the cost of options when they appear on the income statement. Expensing options is not about making investors comfortable with the stock price, because I don’t think the action will really affect the stock price.

5. Are stock options at the root of accounting scandals because they encourage short-term fixes to inflate a company’s share price?

Coke: No. The accounting problems that involved short-term thinking focused on a few high profile blow-ups. In general, stock options are a good way to tie management and employees to shareholder goals. Options also help attract and maintain highly prized workers.

I think you start to go awry when you kid yourself that options don’t have a cost to shareholders, and hand out huge grants. The gaming that went on was, for the most part, between complicit parties. By that I mean that management and investors that once used standard earnings metrics were throwing good methodology out the window. They started to base valuations, for instance, on how many eyeballs a company drew to their Website. When did that ever translate into net profits for shareholders?