About 15 years ago, around the time of Sarbanes Oxley but in a separate action the Financial Accounting Standards Board (FASB) decided that stock options should be treated as compensation income and an expense to a company’s operating statement. Prior to this many stock options were not considered as compensation expense. They were treated as an equity issue and voted by the Board and reported as an increase in outstanding stock shares. Since there was no cash outlay for the stock and it had no compensation value on the day it was issued it was not treated as an expense.
I always found it easy to look at a company’s annual report and see how much equity was being designated for the employees. This percentage of outstanding shares for employees would vary from 5% in older more stable companies to as much as 18% in high growth newer companies. With today’s GAAP/non-GAAP reporting I find this information much more difficult to find.
Further, prior to this action, there was extensive use of Incentive Stock Options (ISO’s) which were given to employees including executives at a price equal to the market value of the stock at the time of issue. In other words they had no value on the day of issue and no value going forward unless the price of the stock increased. Then the employee could reap the benefit of the difference in price between the market price and their issue price (time the number of shares they were given). The logic was if the company increased its value in the marketplace, employees as well as stock holders would reap financial benefits. A reasonable incentive it seemed to me.
Alternatively, Restricted Stock Options (RSO) were usually given at a discounted price and the difference between the employee’s price and the market price has always been treated as compensation expense. 15 years ago RSO’s were used minimally and only for executives as part of their compensation incentive.
Today, ISO’s are used rarely. The number of employees who receive stock options is dramatically less, most notably in public companies. And executives are the beneficiary of restricted shares often priced to them at no cost. For shareholders this means fewer stock options are generated for employees which those with significant investments in the market (read “rich people”) will tell you this is good.
Another negative aspect in my opinion is that the incentive for executives has been changed from growing the value of the company to surviving through the vesting period. It is not unusual for an executive to join a company stay 4 or 5 years and leave with a bundle of money from his/her RSO’s regardless of whether the company grew in value or not.
Maybe I’m old fashioned but I liked the idea of incenting executives and employees to grow the company’s value and for all to share in success. For employees it didn’t have the financial impact that it had for executives, of course. But it could be a new car, a new house, a college education paid for. Today’s professional employee instead can look forward to a 3% raise every year.