It doesn’t have to be 100% accurate, does it? It just has to be as accurate as everything else in the future business projections.
I’m pretty much of the opinion they were asking for this by footnoting enormous liabilities back in the 1990s.
No, but it has some significant impact. I can’t give options to most of my people next year because of the really big expense to the company, even though it isn’t real. You’ve got a stock at about $32, people have 10 years to exercise them, some will exercise them with a pretty small increase (assuming it goes up,) some will wait and never exercise them, a number of people will leave the company and thus their options behind, etc. So you enter the stock and it’s record of volatility into this equation and the company (pretty small) gets hit with a few million dollars of expenses that go against our bottom line earnings. A number that is pretty much vapor at this point. I have not seen how or if you get any credit as a company if the stock never hits that price or the exercised options never hit the amount you are charged.
It really SHOULD be materially accurate, if it’s going to be in financial statements. Of course, what’s considered an immaterial rounding error under materiality calculations when you’re talking the financials of F-5 companies is considered obscenely large dollar amounts under almost all other circumstances. But since there’s not even a realistic expectation that options could be correctly valued, disclosure in the notes to the statements is in fact a more logical choice.
But, as anything business-related that was developed by “round it to the nearest billion” economists and hack lawyer Congressmen, it’s fubar illogical.
Of course, on the other side, you have CEO’s using reporting loopholes to loot their corporations, so it’s really a bit of a catch-22. It would make more sense IMO to remove the stupid deductability thresholds on executive cash compensation, and take measures to make option pay a less attractive alternative (or less tax-beneficial, anyway). At least that’s somewhat transparent and its effects reportable with current earnings.
I’ve never really seen a good reply to Buffet’s one-liner on this: if they’re so worthless and hard to estimate the value of, how come everyone is so eager to have them and hand them out? I also never seen why options are used instead of stock unless it’s to silently fleece people, but oh well.
I do agree the stupid CEO deductability cap should be removed, though.
I guess I’d respond that I’ve never heard anyone assert that they’re worthless. That’d be a position that’d get you laughed out of a serious discussion.
Beyond that, the difficulty in estimating their value in order to make them even remotely useful in current financials isn’t really related in any way to why people like to get them and companies like them as a compensation method. They’re better than lottery tickets; they give the receiver potential ownership of the company; they create the win-win of giving employees additional financial rewards for their work in furthering the company’s goals (when they aren’t just spurring the C-suite members to falsify earnings, that is); the cost is tax-advantaged over cash comp when they’re exercised. None of which has anything to do with what makes their required reporting nonsensical from a generally accepted accounting principles standpoint.
Buffet is no doubt a brilliant investor, but the guy is positively Yogi Berran in his statements sometimes.
That is an absolutely stupid comment - Buffet is too knowledgeable for it to be attributed to ignorance.
There are several well known reasons you use options instead of stock, one of which is incentive to keep good people in the company, since you typically lose your options if you leave and there are usually some restrictions on how soon you can exercise them. They can be worth a lot if you bust your butt and grow the company, although the element of circumstances always makes them an unknown. Silently fleece people? I don’t even understand what that means. Everyone knows exactly what they are getting when they get options, what they are and what they aren’t. What no one knows is what the value will actually be on exercise, and even if the company goes from 30 to 100 you can’t predict who will exercise how many at what price point.
“Why options instead of stock” was my addition; “if they’re so hard to estimate and worthless why is everyone so fired up to use them” is Buffet’s.
They’re a subtle way to inflate the bottom line; you can hide all sorts of shit in there. This probably isn’t as big of a problem now after the 1990s disasters woke everyone up.
There’s still create plenty of incentive conflicts between the owners of a public company and the managers that get these options, though. If they’re used as a significant fraction of compensation, they provide a big push to engage in risky behavior, always doubling down on your investment choice - after all, what do the managers have to lose? If the bet doesn’t pay off, the shareholders lose the potential profits and the investment in the first place, not the managers.
Companies have enough problems with insider/outsider information differences and differing incentives to add another one to the pile.
Oh, and fundamentally, options are basically taking future possible profits and using them to compensate people today to get them to work harder, but only if the company performs well, right? Why not sell the options on the open market and then give the actual money to the employees if the company meets targets? If the options aren’t being used to exploit information differences, there shouldn’t be a difference in compensation to the employees at all. I don’t think it’s coincidental that most of the execs who love options are so opposed to this suggestion when it comes up.
You’re missing the whole point, as usual. Nobody has suggested that they’re always worthless – the point is that it’s impossible to calculate their value with any meaningful certainty, because there are too many contingent variables – they basically could be worth a lot, a little, or nothing at all, and there’s no way of knowing any more than you can calculate what a company’s share price will be in the future.
The whole point of public disclosure is to allow people to make informed investment decisions. If you introduce extraneous estimates that are likely to be inaccurate, are you really helping people to make more informed decisions? The most accurate disclosure is just revealing the number of options outstanding, their exercise prices, their vesting periods, and perhaps their dilutive effect on current share price if you assume that various portions of them were exercised.
No financial analyst is “confused” by the relevance of outstanding options, so this additional projection is solely intended to help more casual investors better understand their dilutive relevance – but projections are inherently misleading (which is why they are strictly regulated under securities laws), so are we really helping retail investors by deliberately introducing these sorts of projections (at a time when there was a strong movement to ban projections in general, for the same reason?)
If it’s impossible to estimate their future value, how come managers and employees like them so much?
Did you even read my response?
I do not understand this. Are you saying that because someone likes something, it is possible to give a firm fair market valuation of it?
Spot on. What’s the old quote - “there is no problem so insignificant, that intervention by government can’t make it significantly worse” purple monkey dishwasher?
Jason, reading your posts on this topic, you are so paranoid that the managers and other people running companies are inherently evil that I can’t imagine you working for a company. We’ve already answered this question: because if the company grows you can share in the financial benefits and make some money. I AM a manager and have been in companies for years, and I’ve given out and received benefits, and as hard as it may be to believe my peers and I aren’t doing all the immoral manipulation and deception that you’re ascribing to get the stock price up temporarily so we can cash in, to fleece the shareholders. I spend 10 or more hours a day trying to do what I can to make the company successful and help it grow in a substantial way, for a variety of reasons: A good strong company provides better employment security for me and my co-workers, it provides more opportunity for career growth if the company does well, and I like doing my job well. There are no plots to do dumb things or to make risky short term bets that might move the stock for a few months and then have it collapse when we ultimately lose - that’s just dumb.
There’s nothing secret or hidden about options. And there’s nothing evil about them. They are just not a predictable commodity.
Microsoft, no less! ;)
Yeah the King of Options (because people will accept a lower paycheck with more options in a successful company).
Microsoft doesn’t give out options anymore. Even if they did, it doesn’t change my opinions.
Desslock, yes, I read your post. I still don’t see why managers or employees would be interested in stock options if this is an accurate statement:
You’re missing the whole point, as usual. Nobody has suggested that they’re always worthless – the point is that it’s impossible to calculate their value with any meaningful certainty, because there are too many contingent variables – they basically could be worth a lot, a little, or nothing at all, and there’s no way of knowing any more than you can calculate what a company’s share price will be in the future.
I didn’t say they’re “always worthless”, but who the hell wants to take a form of compensation that they have no idea what it’s worth? If they have no idea what they’re worth, why does everyone want them so very badly? This is especially ridiculous in light of the healty publically traded options market out there; impossible to value my ass.
Oh, please. When companies or projects fail, it’s not because some evil well-placed person is plotting it, or looting the company - it’s because a lot of well meaning people have the wrong incentives when they make decisions. My only point is that stock options give some damned odd incentives compared to other forms of compensation, and bad incentives give you bad results. There’s no morality story here.
I will offer you a choice, Mr. McCullough: I will either send you an undisclosed sum of money, or nothing at all. Which would you rather have?
Bad analogy - companies aren’t offering employees options or nothing to retain and give incentives. It could just as easily be stock on X future date, cash tied to stock performance, or a dozen other things.
So you are saying that something is either worth nothing or has a readily definable value? You do understand that stock options are also publicly traded, and the option is paid for. If you are so certain with defining value, you should be able to make a mint.
I mean things like this:
I didn’t say they’re “always worthless”, but who the hell wants to take a form of compensation that they have no idea what it’s worth? If they have no idea what they’re worth, why does everyone want them so very badly? This is especially ridiculous in light of the healty publically traded options market out there; impossible to value my ass.
just make no sense. Are you serious? That in order to find something valuable, I have to know what it is worth? Has it occurred to you that of two different people, one might not accept a pay cut (or work for $X-Y) because one does not think the options replacing Y are sufficient, while the other might think he’s getting a great deal by getting those options and giving up so little pay?
Have you seen eBay? I have often discovered that things like games, which apparently have some value to people, are often difficult to price exactly. It often seems that a hot game one week will lose value later. Meanwhile, an out of print game that has languished in obscurity for years will become popular and the price goes through the roof. However, because people apparently disagree on exactly what it is worth, it must be worth nothing. That out of print game must be worthless, since it can not be valued exactly.
You should take up professional arbitraging, with your certain knowledge of the fair market value of products.
OK - so tell me what my recent options are going to be worth. I have 10 years to trade them in. Tell me at which price I should sell them and be sure that I get the most money for them, and not regret holding them when the company wins the XX business in two years and the stock doubles. Or at what price I should sell them in the next 10 years because the stock will drop below that price and never come back. A good number of people here have a lot of options that are expiring “underwater” - the stock price is less that the option price. And some people in that same offering made a nice little piece of cash. Could you have predicted how many of each there would have been?
To directly answer your question “If they have no idea what they’re worth, why does everyone want them so very badly?” - well, let me ask you, why do you think I want them? You either think I’m lying about why I want them or you think I’m stupid because I sure as hell have no idea whether these options will pay for a kid’s college in the next few years or maybe pay for a nice dinner. Or nothing at all. You assert that I should know what they are worth: then tell me what they are going to be worth so I can start planning on them. In fact, if you can tell me what they will be worth I’ll get real rich, because that means you can predict stock prices.