A rising chorus of complaints from institutional investors about corporate accounting practices could force Canadian employers to change how they use stock options to compensate employees.
Last month, Toronto Dominion bank announced it would soon begin to recognize stock option benefits as a compensation expense. Bank of Montreal followed suit a few days later.
There is a global push to change how companies handle stock options, said Raymond Murrill, executive compensation practice leader of consulting firm Watson Wyatt. If companies don’t make the change on their own, it is likely regulators will force them to. When that happens, it will make a lot of organizations think twice about how they use stock options, he said.
Critics of current stock option practices don’t like companies issuing stock options to employees without adding the value to compensation expenses. Institutional investors have become increasingly vocal about how the excessive issuing of options not only dilutes share value for shareholders but also distorts impressions of the true value of a company.
In the past, companies could add stock options to a compensation package and there was no apparent cost, said Murrill. “There is a sort of hidden cost which is the dilution, but when it comes to looking at (the) package, the options appear to be free,” he said.
Investors feel options aren’t being used in an effective manner, said Murrill. “They think they are just being given away too freely. If you have to justify something, you are going to be a little more cautious,” he said. “(This) will require companies to be more prudent in their use of stock options.”
Last September, the Canadian Institute of Chartered Accountants (CICA) approved new standards for stock-based compensation. Companies are being encouraged to expense the value of the share. If they don’t, they must disclose the impact of the options on profit and loss in all financial statements. Institutional investors say this is fine for themselves, they have staff to wade through documents to figure out the cost, but when the numbers are hidden in footnotes, it is still difficult for the average investor to figure out the effect of stock options.
By not making the rules mandatory, accountants have effectively given companies the opportunity to opt out and only include the changes in footnotes on annual statements, said Murrill.
The Ontario Teachers Pension Fund has for some time opposed what it calls excessive use of stock options. In March, Claude Lamoureux, CEO of the pension plan board, told the Canadian Club of Toronto that the CICA is failing Canadian investors by not requiring the value of stock options to be deducted on the income statement as “it represents a future drain on profits for existing shareholders.”
On the same day BMO made its announcement, fund manager Beutel Goodman & Co. wrote letters to about 300 companies listed on the Toronto Stock Exchange asking them to change how they account for stock options. “We just simply want transparency,” said George Klar, vice-president. “Shareholders should know all the cost of running a business. Period. Full stop.”
Now that TD and BMO have made the change, it is likely the other three big banks will follow suit, said Murrill, but so long as the U.S. doesn’t require companies to expense stock options there will be resistance to making the practice mandatory in Canada. However the issue is getting a lot of attention south of the border, particularly after the Enron fiasco.
For years, investment guru Warren Buffett has been critical about accounting practices for stock options, famously referring to them in his 1999 letter to shareholders as “Alice-in-Wonderland” stuff.
“In effect, accounting principles offer management a choice: Pay employees in one form and count the cost, or pay them in another form and ignore the cost. Small wonder then that the use of options has mushroomed,” said Buffett.
In a column he wrote earlier this year, Buffett asked “If options aren’t a from of compensation, what are they? If compensation isn’t an expense, what is it? And if expenses shouldn’t go into the calculation of earnings, where in the world should they go?”
The chair of the U. S. Federal Reserve, Alan Greenspan, has also indicated he would like to see changes to how stock options are expensed and the issue has made it to the floor of the U.S. congress where Senator John McCain has proposed federal legislation forcing companies to expense options.
Karen Maidment, the Bank of Montreal’s chief financial officer, said the change will have little impact on how the bank awards stock options and will only increase costs by about two to four cents a share in 2003, rising over four years to about eight cents.
It is has been estimated that charging option expenses to the profit and loss statement could reduce the net income of a typical Dow Jones company by nine per cent.
Intel CEO Craig Barrett has suggested expensing stock options only for the firm’s top five executives but making no changes to how staff options are accounted for. Intel grants options to all of its 85,000 employees and claims that if it had to expense all options it would be forced to reduce its program.
Last month, Toronto Dominion bank announced it would soon begin to recognize stock option benefits as a compensation expense. Bank of Montreal followed suit a few days later.
There is a global push to change how companies handle stock options, said Raymond Murrill, executive compensation practice leader of consulting firm Watson Wyatt. If companies don’t make the change on their own, it is likely regulators will force them to. When that happens, it will make a lot of organizations think twice about how they use stock options, he said.
Critics of current stock option practices don’t like companies issuing stock options to employees without adding the value to compensation expenses. Institutional investors have become increasingly vocal about how the excessive issuing of options not only dilutes share value for shareholders but also distorts impressions of the true value of a company.
In the past, companies could add stock options to a compensation package and there was no apparent cost, said Murrill. “There is a sort of hidden cost which is the dilution, but when it comes to looking at (the) package, the options appear to be free,” he said.
Investors feel options aren’t being used in an effective manner, said Murrill. “They think they are just being given away too freely. If you have to justify something, you are going to be a little more cautious,” he said. “(This) will require companies to be more prudent in their use of stock options.”
Last September, the Canadian Institute of Chartered Accountants (CICA) approved new standards for stock-based compensation. Companies are being encouraged to expense the value of the share. If they don’t, they must disclose the impact of the options on profit and loss in all financial statements. Institutional investors say this is fine for themselves, they have staff to wade through documents to figure out the cost, but when the numbers are hidden in footnotes, it is still difficult for the average investor to figure out the effect of stock options.
By not making the rules mandatory, accountants have effectively given companies the opportunity to opt out and only include the changes in footnotes on annual statements, said Murrill.
The Ontario Teachers Pension Fund has for some time opposed what it calls excessive use of stock options. In March, Claude Lamoureux, CEO of the pension plan board, told the Canadian Club of Toronto that the CICA is failing Canadian investors by not requiring the value of stock options to be deducted on the income statement as “it represents a future drain on profits for existing shareholders.”
On the same day BMO made its announcement, fund manager Beutel Goodman & Co. wrote letters to about 300 companies listed on the Toronto Stock Exchange asking them to change how they account for stock options. “We just simply want transparency,” said George Klar, vice-president. “Shareholders should know all the cost of running a business. Period. Full stop.”
Now that TD and BMO have made the change, it is likely the other three big banks will follow suit, said Murrill, but so long as the U.S. doesn’t require companies to expense stock options there will be resistance to making the practice mandatory in Canada. However the issue is getting a lot of attention south of the border, particularly after the Enron fiasco.
For years, investment guru Warren Buffett has been critical about accounting practices for stock options, famously referring to them in his 1999 letter to shareholders as “Alice-in-Wonderland” stuff.
“In effect, accounting principles offer management a choice: Pay employees in one form and count the cost, or pay them in another form and ignore the cost. Small wonder then that the use of options has mushroomed,” said Buffett.
In a column he wrote earlier this year, Buffett asked “If options aren’t a from of compensation, what are they? If compensation isn’t an expense, what is it? And if expenses shouldn’t go into the calculation of earnings, where in the world should they go?”
The chair of the U. S. Federal Reserve, Alan Greenspan, has also indicated he would like to see changes to how stock options are expensed and the issue has made it to the floor of the U.S. congress where Senator John McCain has proposed federal legislation forcing companies to expense options.
Karen Maidment, the Bank of Montreal’s chief financial officer, said the change will have little impact on how the bank awards stock options and will only increase costs by about two to four cents a share in 2003, rising over four years to about eight cents.
It is has been estimated that charging option expenses to the profit and loss statement could reduce the net income of a typical Dow Jones company by nine per cent.
Intel CEO Craig Barrett has suggested expensing stock options only for the firm’s top five executives but making no changes to how staff options are accounted for. Intel grants options to all of its 85,000 employees and claims that if it had to expense all options it would be forced to reduce its program.
