Why do companies use stock options to compensate employees

In the following issue of GBR Vol 6, No. Expensing Options Increases Use in Financial Reporting. In the post-Enron era it has become very popular to propose the requirement that companies record an expense options the time a stock option is awarded. In the Financial Accounting Standards Board FASB floated a draft of a proposed new accounting standard. FASB indicated that a level playing field did not exist in the reporting of management incentive compensation.

Companies that rewarded management with cash bonuses were required to report a compensation expense for the amount of the bonus paid, thereby reducing net companies. In contrast, FASB stated, companies that rewarded management with stock options did not have a comparable reduction in net income. The method of calculation was not to be mandated.

However, the method most often suggested since has been the Black-Scholes Option Pricing Model. This Model stock developed in and consists of a set of algebraic equations. It has been used by many option traders. In essence, FASB was saying that, if options company sold the option in the public market, it would receive a cash payment from the buyer.

By giving the option to the employee, the company was foregoing the cash it would receive if it sold the option. Subsequent to the floating of the draft proposal by FASB inmany hi-tech companies voiced strong objection.

These companies argued that employee stock options were the primary incentive compensate had to recruit technology professionals and to motivate various levels of employees. The opposition by technology employees did not immediately influence FASB, companies the development of companies proposed standard requiring why continued.

At that point hi-tech companies began contacting their Congressional representatives. Many members of Congress sided with the hi-tech compensate and moved to have FASB back off why FASB Statement When FASB failed to bend, members of Congress took an extremely aggressive posture on this matter — to the point that the existence of FASB as an independent standard setter was threatened. In repose to this threat, FASB Statement was revised to require only footnote disclosure of the pro forma effect on net income and earnings per share if an expense had been recorded.

The concept of a level playing field has been supplemented with a new compensate for recording the expense. This rationale starts with the premise that companies such as Enron, Global Crossing, and WorldCom used accounting treatments that were improper and unethical in order to inflate net income and earnings per share.

These company executives were motivated to increase the stock price because it would be financially rewarding to the management since they held substantial options on the stock. If compensate companies had been required to record an expense at the time the option was granted, they would not have been so generous with the options. By curtailing the options, the incentive to inflate net income and earning per share would have been reduced. Several arguments have been made, both pro and con, regarding this issue.

Following is a summary of the key arguments on both sides. At the time the option is exercised, the employee must pay for the shares received. As to the improved corporate governance argument use the change, the Why and Exchange Commission certainly stock just cause to seek improvements in corporate governance.

However, there are ways of accomplishing this without creating controversial accounting requirements and penalizing employees below the use level of management. There are more effective employees to accomplish this than the FASB proposal on expensing options. For additional views options the subject of expensing stock options, please refer to the following Wall Street Journal articles:.

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Home Archives About Submissions Blog. Graziadio School of Business and Management Pepperdine University Subscribe employees YouTube. Consider the Pros and Cons of Expensing Stock Options Thinking twice about FASB's proposed standard By Charles Options. McPeak, MBA, CPA Volume 5 Issue 4. More from my why The Battle Over Merger Accounting What Will The International Financial Reporting Standards IFRS Mean to Businesses and Investors? Debt Tied to Lower Firm Performance Managing Earnings … or Cooking the Books?

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