The Conceptual Framework and Accounting for Employee Stock Options – Micron Technologies

As part of its due process, the Financial Accounting Standards Board (FASB) gathers feedback on itsproposed standards. In many cases the organizations or persons responding provide useful informationbecause they provide a viewpoint the FASB has not fully considered or else provide technical informationabout a particular industry or practice the FASB has failed to consider. In this assignment, you will learn some basic background about what an employee stock option is, how itworks. With that background information you are going to evaluate the arguments raised by the CFO ofMicron Technology in his letter providing feedback to the FASB on the proposed standard on share-basedpayments that later was finalized as SFAS 123R, Share-Based Payments. SFAS 123R, later codified asASC 718, requires companies to recognize expenses using the fair value of the stock options granted toexecutives and employees.Required:Read the first three pages of the of the article “How do employee stock options work,” by Samuel Deaneof Morningstar. Then read the comment letter from Micorn’s CFO. Write a memo using the format inthe Memo Guidelines to address the following three questions: 1. Briefly describe what an employee stock option is and how it works? Why might an employer wantto use employee stock options, vs other forms of compensation? Why might employees wantemployee stock options, vs other forms of compensation?2. The first two logical arguments raised by Micron by the main points of their memo are: a. Employee stock options granted at market price do not constitute an “expense” under presentaccounting definitions, do not represent an economic cost to the issuer and should not berecognized as a compensation expense of the issuing company.b. The measurement methodologies and tools recommended by FASB rely significantly onmanagement judgments and estimates and will lead to a lack of consistency andcomparability among reported results. Do the principles in the FASB’s conceptual framework lead you to agree or disagree with each ofthese two arguments raised by Micron? Discuss each argument separately, identify relevant aspectsof the conceptual framework that you believe are relevant to the arguments being made by Micron.Be sure to explain why the conceptual framework supports or contradicts the arguments being madeby Micron.3. Based on your general understanding of the FASB’s conceptual framework and the debate overexpensing stock-based compensation, would you support or oppose to FASB’s requirement ofrecognizing stock-based compensation expense measured using fair value? Explain your answer andprovide justification for your views. Be sure to draw from the various aspects of the conceptualframework. There is not necessarily right or wrong answer to each question. Express your opinion and back them upwith facts and reasoning, particularly reasoning based on the conceptual framework. Do some researchonline. You can use all available literature as reference, including those listed below. Be sure to cite anysources that you use to develop insights or provide direct quotes from (e.g., sections of the codification,articles).Your memo should be no more than four pages. You should use 12-point Times New Roman font, oneinch margin on all sides, double spacing in the main text and single spacing in the header. American Economic Association
Accounting for Employee Stock Options
Author(s): Wayne Guay, S. P. Kothari and Richard Sloan
Source: The American Economic Review, Vol. 93, No. 2, Papers and Proceedings of the
OneHundred Fifteenth Annual Meeting of the American Economic Association, Washington,DC,
January 3-5, 2003 (May, 2003), pp. 405-409
Published by: American Economic Association
Stable URL: https://www.jstor.org/stable/3132262
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Accounting for Employee Stock Options By WAYNE GUAY, S. P. KOTHARI, AND RICHARD
SLOAN* Employee stock options (ESO’s) are a ubiq- uitous form of compensation in corporate
America. By the late 1990’s, ESO’s outstanding at large corporations averaged 7 percent of total
outstanding shares, with top executives holding approximately one-third of total ESO’s (John Core
and Guay, 2001). Empirical evidence sug- gests that firms use ESO’s to align employees’ and
shareholders’ interests, attract and retain employees, and compensate employees for their labor
while simultaneously raising capital from employees (Core and Guay, 1999, 2001; Kevin J. Murphy,
1999). There is currently an intense debate nation- ally and internationally among standard-setters,
politicians, investors, corporate executives, and academics about whether to require corpora- tions
to deduct the estimated value of ESO grants as a business expense in reported income. Existing
accounting standards require firms to expense most forms of pay, such as salaries, cash bonuses,
and the value of stock grants, but allow firms to choose whether to expense the value of ESO
grants. Until very recently, nearly all firms chose not to expense ESO’s. However, firms that do not
expense ESO’s must publicly disclose in the financial statement footnotes what reported income
would have been if the ESO’s were expensed. In a recent sample of large growth firms, Christine
Botosan and Marlene Plumlee (2001) find that mandatory expensing of ESO’s would have resulted
in a 14-percent median reduction in firms’ earnings per share. Firms are also required to disclose
details of top-executive ESO compensation in the annual proxy statement. Underlying the ESO
debate is the concern that the choice among alternative financial- accounting treatments have real
economic con- sequences. A large literature beginning with * Guay: Wharton School, University of
Pennsylvania, Philadelphia, PA 19104; Kothari: Sloan School of Manage- ment, Massachusetts
Institute of Technology, Cambridge, MA 02142; Sloan: University of Michigan Business School, Ann
Arbor, MI 48109-1234. We acknowledge helpful com- ments of John Core, Rich Frankel, and Joe
Weber. 405 Ross Watts and Jerold Zimmerman (1978) pro- vides evidence that accounting choice
can im- pose economic costs on firms when contracts (e.g., debt and executive compensation contracts) or influential external parties (e.g., tax authorities) rely on reported accounting num- bers (see
Thomas Fields et al. [2001] for a survey of this literature). Accounting choice can also have
economic consequences if investors fixate on particular numbers, such as reported earnings,
resulting in security mispricing and misallocation of capital. Proponents of mandatory expensing
argue that ESO’s reflect a cost of acquiring employee labor, and that expensing ESO’s conveys this
information to outsiders consistently with other labor costs. Some argue that the absence of ESO
expense results in stock mispricings, because investors fixate on reported earnings and fail to
understand or utilize supplemental footnote dis- closures about the true economic cost of ESO
grants. Others argue that, when investors and boards of directors fixate on accounting earn- ings,
the absence of ESO expense exacerbates ineffective corporate governance and allows
management to use ESO’s to extract excessive compensation. Proponents of this view argue that
expensing ESO’s will reign in management compensation by putting it under a brighter light.
Opponents of expensing ESO’s argue that deducting the cost of ESO’s from earnings con- veys an
impression of weaker financial results to investors and, under the assumption that in- vestors fixate
on reported earnings, could raise the firms’ cost of financing and stifle corporate investment and
innovation. There is also a con- cern that external parties, such as taxing author- ities, might use
changes in financial-accounting treatment as a cue to alter regulatory and tax policy. I. Accounting
Issues The ESO transaction involves the exchange of labor inputs for a contingent equity claim on
AEA PAPERS AND PROCEEDINGS the firm, and it raises several complex account- ing issues. We
consider three such issues below. A. ESO Issuance Combines Operating and Financing Activities
Granting ESO’s is economically equivalent to two separate transactions. In the first trans- action, the
firm sells warrants to the employee for cash. This is a pure financing transaction, resulting in the
generation of cash and an in- crease in the firm’s equity capital. In the second transaction, the firm
pays the cash to the em- ployee as compensation for services rendered. This is a pure operating
transaction, resulting in the subsequent use of resources and a corre- sponding charge to earnings.
Thus, consistent with the existing accounting for stock grants to employees, the proper accounting
treatment for an ESO grant is an entry to increase contributed equity capital and an entry to deduct
the value of ESO’s from reported earnings. To see this point, consider two economically equivalent
firms: firm A issues common-stock warrants to investors for cash and then uses cash to pay for all
production inputs; firm B uses ESO’s to pay for all production inputs. Firm A computes earnings as
revenue received from the sale of the inputs less the purchase price of the inputs. Assuming no
expense for ESO’s, firm B’s earnings equal revenues. Thus, earnings are very different across the
two firms, yet both firms raise the same amount of capital and gen- erate the same economic
earnings. Many prominent business leaders, such as Harvey Golub (former CEO, American Express) and Andrew Grove (CEO, Intel), argue passionately against expensing ESO’ s. Their argument is that the economic impact of ESO’s manifests itself through shareholder dilution, and that
the denominator in the computation of earnings per share (EPS) already adequately captures the
“dilution cost” of ESO’s. As a result, expensing ESO’s essentially double- counts the cost of ESO’s.
As background, for a firm with common stock and ESO’s outstand- ing, the denominator in the
computation of EPS is the sum of (i) the average number of out- standing common shares and (ii)
an adjustment for outstanding ESO’s based on a formula that converts the number of outstanding
ESO’s into an “equivalent” number of common shares. However, the above argument is flawed. It
makes the mistake of confusing the financing implications of raising equity capital with the operating
costs of paying for operating re- sources. To clarify this point, consider the fol- lowing two firms. Firm
A initially holds $200 in assets funded by 20 shares of common stock issued at $10 per share. Firm
A sells the assets for $220, recognizes $220 of revenue and $200 of expense. Earnings are $20,
and EPS is $1 ($20/20 shares), reflecting a 10-percent return on equity capital. Firm B holds $100 in
assets funded by 10 shares of common stock issued at $10 per share and also grants $100 of stock
to a new employee in return for labor worth $100. Firm B then sells the assets and labor for $220. If
the cost of the new labor is not expensed, firm B recognizes $220 of revenues and $100 of expense.
Earnings are $120, and EPS is $6 ($120/20 shares), reflecting a 60-percent return on equity capital.
Although both firms generate a 10-percent eco- nomic return on capital, firm B’s EPS reflects a
misleading accounting return of 60 percent on capital. Note that, because the denominator of firm
B’s EPS includes an adjustment for the 10 shares of stock issued to acquire labor, the prob- lem with
firm B’s EPS stems solely from the failure to deduct labor expense from reported earnings in the
numerator. This example illus- trates the need for an EPS measure where (i) the numerator of EPS
includes a deduction for ESO grants to reflect the cost of the labor resources received by the firm
upon granting the option, and (ii) the denominator includes an adjust- ment for outstanding shares
and ESO’s to reflect the fact that existing shareholders and option hold- ers have an economic claim
on the firm’s earnings performance.1 Although the above ex- ample assumes stock shares (not
ESO’s) are granted to acquire labor, the economic intuition is identical when ESO’s are granted to
acquire labor (see Dieter Hess and Erik Lueders, 2001; Core et al., 2002). 1 Core et al. (2002)
document that, although an ESO adjustment to the denominator of EPS is indeed necessary, the
current accounting rules require an adjustment that understates the economic dilution of outstanding
ESO’s by about 50 percent, on average. 406 MAY 2003
LESSONS FROM ENRON B. ESO Grants Are a Barter Transaction Granting ESO’s is a barter
transaction in- volving the exchange of labor services for a contingent equity claim. As with all barter
transactions, determination of the fair value of the exchange is an accounting issue. Although optionpricing techniques (e.g., Black-Scholes) are well developed, ESO’s have features, such as vesting
provisions, nontransferability, and accelerated maturity when the holder terminates employment, that
deviate from the assumptions underlying standard option-pricing models for publicly traded options.
As a result, managers’ exercise policies likely deviate from the as- sumptions underlying the BlackScholes frame- work (e.g., Steven Huddart, 1994; Charles Cuny and Philippe Jorion, 1995).
Reasonable solu- tions to this problem have been proposed in which ESO’s are valued using the
expected time until exercise (e.g., Thomas Hemmer et al., 1994). Accounting standard-setters are
often reluc- tant to recognize numbers in the financial state- ments that cannot be measured reliably
(e.g., research and development expenditures are not recognized as assets because it is argued
that the future benefits of these expenditures cannot be reliably estimated). Some argue that ESO’s
should not be expensed for this reason. Further, empirical evidence suggests that some firms use
discretion in the assumptions underlying ESO valuation to manipulate ESO expense (David Aboody
et al., 2002). However, we believe that ESO grant valuation is no more complicated than the
estimation of many other common cor- porate expenses (e.g., the annual expense recog- nized for
pensions and postretirement benefits is based on estimates of the present value of future retirement
benefits earned by current employees during the year). A related argument is that, because employees are risk-averse and are not allowed to con- struct the type of risk free hedges that form the basis
for option pricing models, traditional option- pricing models may overvalue ESO grants from the
employee’s perspective (e.g., Brian Hall and Murphy, 2002). Some firms use these argu- ments to
justify either a lower option expense or to bolster the case against the reliable measure- ment of
ESO value. However, regardless of employees’ valuation of ESO’s, it is the cost of the ESO grant to
the firm’s existing owners rather than the employees’ valuation that mat- ters when determining the
appropriate amount to expense. To illustrate, companies sometimes reward employees with fringe
benefits for in- centive or reward purposes, such as first-class air tickets or country-club
memberships. The fact that some employees value these perqui- sites at less than company cost
does not mean that the company should expense these benefits at less than cost. C. ESO’s as a
Contingent Financial Obligation Through Time A third issue arising in expensing ESO’s is the
treatment of changes in the fair value of the contingent equity claim between the grant and exercise
dates. The amount of value the option holder ultimately receives depends on the exer- cise value
(i.e., share price) at the exercise date. Thus, because option-holders bear risk associ- ated with
changes in equity value over time, ESO’s provide existing shareholders with a form of insurance
against future firm performance. An interesting accounting issue is whether the ex post realization of
the risk borne by the option holders should be reflected in firm earn- ings. That is, should changes in
ESO value between the grant and exercise dates be in- cluded as a component of earnings to
reflect the fact that option-holders receive a portion of any change in the net asset value of the firm?
Such an approach is consistent with an accounting objective where earnings appropriately reflect
any change in the common stockholders’ net assets (i.e., assets less liabilities). A problem with this
approach is that the change in ESO portfolio value reflects changes in the firm’s stock price, and
stock price reflects the capitalized change in the present value of expected firm earnings. Because
accounting earnings generally do not reflect changes in the present value of most assets, markingto-market some components of equity, but not assets, may result in an earnings stream that hinders
market participants in assessing the amounts and risk of firms’ future cash flows.2 2 For example,
consider a technology firm with substan- tial outstanding ESO’s whose stock price rises substantially
VOL. 93 NO. 2 407
AEA PAPERS AND PROCEEDINGS II. Economic Consequences of Expensing ESO’s Accounting
for ESO’s is one of the most controversial accounting issues in recent his- tory. Corporate America
and the major account- ing firms lobbied aggressively against the mandated expensing of stock
options during the 1990’s. Their efforts forced the Financial Ac- counting Standards Board (FASB) to
back down and recommend, but not require, the ex- pensing of ESO’s. The FASB summarizes the
most commonly voiced concern with the man- datory expensing of ESO’s as follows (from “FASB
Preliminary Summary of Responses to Exposure Draft,” issued 30 June 1993): Respondents who
objected to the pro- posed accounting on the basis of public policy concerns asserted that the
recogni- tion of compensation costs for fixed stock options will result in lower stock prices and higher
costs of capital and will there- fore cause many companies to eliminate or significantly curtail their
stock-price based compensation programs. Firms publicly disclose details of ESO plans in their
financial statements, including the esti- mated cost of option grants and the total number of ESO’s
outstanding. Details about the level and composition of top executives’ compensa- tion, including the
estimated value of the ESO grants, are disclosed publicly in the annual proxy statement. Thus, the
concern described above relies on a form of market inefficiency where marginal investors fixate on
reported earnings and ignore information about business expenses not explicitly recognized in
contem- poraneous earnings. Accumulated empirical re- search over the past four decades
contradicts this extreme form of market inefficiency (for evidence that investors do not ignore ESO
dis- closures see Aboody [1996] and Timothy Bell et al. [2002]). Even if markets were character- due
to good news about future sales from a newly patented product. If the firm expenses the increase in
ESO value that results from the increased stock price, the firm will experi- ence a sharp decline in
reported earnings in a period where good news occurs. The potential informational problem here
stems from the fact that reported accounting earnings in general do not capture large portions of the
information reflected in current stock returns. ized by such inefficiency, however, it would seem to
strengthen the case for recognizing these very real costs in earnings. Given these arguments, why
are many firms and executives so staunchly opposed to the ex- pensing of options? Equally
importantly, what would be the benefit of changing accounting to require coporations to expense
ESO’s? One hypothesis for executives’ opposition to expensing ESO’s, is that it would influence
con- tracting arrangements by making ESO compen- sation to top executives more visible. This, in
turn, would make it more difficult for top exec- utives in firms characterized by poor corporate
governance to justify awarding themselves ex- cessively lucrative pay packages. Contracting and
transactions costs render corporate gover- nance an imperfect process, and unlike stock prices
(which evidence suggests are influenced primarily by marginal investors), the effective- ness of
corporate governance depends on the actions of all voting shareholders. Individual shareholders
often do not have strong incentives to expend effort on governance activities, and without a
transparent and potentially contract- ible number associated with ESO grants, some top executives
can use ESO’s to transfer wealth from shareholders. Supporting empirical evi- dence finds firms that
most actively lobbied against the expensing of ESO’s are character- ized by having top executives
who receive a greater proportion of their compensation from options, receive higher total
compensation, and use ESO’s more aggressively for themselves versus other employees (Patricia
Dechow et al., 1996). This hypothesis generates an empirical prediction that ESO awards,
especially to top executives, will decline following the manda- tory expensing of ESO’s, particularly
in firms with ineffective corporate governance. Re- cently, many firms have voluntarily expensed the
cost of ESO grants. The hypothesis also predicts that the governance of expensing firms is more
effective than that of the non-expensers.3 3 We note, however, that compensation contracts will only
be written efficiently if boards and investors fully understand both the cost of ESO’s and the
incentive effects of options, stock, cash, and other forms of compensation. Reaching agreement
about the appropriate ESO expense and conveying this information to boards and investors is likely
to be much easier than the difficult tasks of ensuring 408 MAY 2003
LESSONS FROM ENRON A final possibility to explain firms’ opposi- tion is that expensing ESO’s
imposes real eco- nomic costs on firms related to contracting or influential external parties. For
example, lower publicly reported profits due to ESO expense might result in the loss of customer
confidence or more binding debt covenants. Alternatively, young growth firms that rely heavily on
ESO’s may fear that the FASB’s endorsement of ESO expense will prompt the IRS to tax ESO
grants to employees as regular compensation, instead of deferring employee tax until exercise. III.
Conclusion Corporate and political pressures should not determine ESO accounting rules. ESO’s
are a key component of top executive compensation that serve useful contracting functions. However, the goal of accounting is not to distort financial performance to subsidize particular business
activities. Accounting should reflect the true costs of doing business, and labor ac- quired through
ESO grants is a real economic cost that firms should deduct from earnings as an expense. Armed
with clear information on operating costs, investors, creditors, boards of directors, and regulators
should be left to deter- mine business practice. REFERENCES Aboody, David. “Market Valuation of
Employee Stock Options.” Journal of Accounting and Economics, August-December 1996, 22(1- 3),
pp. 357-91. Aboody, David; Barth, Mary and Kasznik, Ron. “Do Firms Manage Stock-Based
Compensa- tion Expense Disclosed Under SFAS 123?” Working paper, Stanford University, 2002.
Bell, Timothy; Landsman, Wayne; Miller, Bruce and Yeh, Shu. ‘The Valuation Implications of
Employee Stock-Option Accounting for Profitable Computer Software Firms.” Account- ing Review,
October 2002, 77(4), pp. 971-96. Botosan, Christine and Plumlee, Marlene. “Stock Option Expense:
The Sword of Damocles that boards and investors understand the incentive effects of various types
of compensation contracts, and understand which contracts are most efficient in certain settings.
Revealed.” Accounting Horizons, December 2001, 15(4), pp. 311-27. Core, John and Guay, Wayne.
“The Use of Eq- uity Grants to Manage Optimal Equity Incen- tive Levels.” Journal of Accounting
and Economics, December 1999, 28(2), pp. 151- 84. . “Stock Option Plans for Non-executive
Employees.” Journal of Financial Econom- ics, August 2001, 61(2), pp. 253-87. Core, John; Guay,
Wayne and Kothari, S. “The Economic Dilution of Employee Stock Op- tions: Diluted EPS for
Valuation and Finan- cial Reporting.” Accounting Review, July 2002, 77(3), pp. 627-52. Cuny,
Charles and Jorion, Philippe. “Valuing Executive Stock Options with a Departure Decision.” Journal
of Accounting and Eco- nomics, September 1995, 20(2), pp. 193-205. Dechow, Patricia; Hutton,
Amy and Sloan, Rich- ard. “Economic Consequences of Accounting for Stock-Based
Compensation.” Journal of Accounting Research, Supplement 1996, 34, pp. 1-20. Fields, Thomas;
Lys, Thomas and Vincent, Linda. “Empirical Research on Accounting Choice.” Journal of Accounting
and Economics, Sep- tember 2001, 31(1-3), pp. 255-307. Hall, Brian and Murphy, Kevin. “Stock
Options for Undiversified Executives.” Journal of Ac- counting and Economics, February 2002,
33(1), pp. 3-42. Hemmer, Thomas; Matsunaga, Steven and Shev- lin, Terry. “Estimating the ‘Fair
Value’ of Employee Stock Options with Expected Early Exercise.” Accounting Horizons, De- cember
1994, 8(4), pp. 23-42. Hess, Dieter and Lueders, Erik. “Accounting for Stock-Based Compensation:
An Ex- tended Clean Surplus Relation.” Working paper, University of Konstanz, Germany, 2001.
Huddart, Steven. “Employee Stock Options.” Journal of Accounting and Economics, Sep- tember
1994, 18(2), pp. 207-31. Murphy, Kevin J. “Executive Compensation,” in Orley Ashenfelter and
David Card, eds., Handbook of labor economics, Vol. 3. Am- sterdam: North-Holland, 1999, pp.
2485-2563. Watts, Ross and Zimmerman, Jerold. “Towards a Positive Theory of the Determination
of Ac- counting Standards.” Accounting Review, January 1978, 53(1), pp. 112-34. VOL. 93 NO. 2
409
ACCOUNTING
For the Last Time: Stock Options Are an Expense
by Zvi Bodie , Robert S. Kaplan and Robert C. Merton
From the March 2003 Issue
T he reporting controversy time has of come has executive been to end going stock the on options debate far too on dates long. accounting
back In fact, to 1972, for the stock rule when governing options; the the the Accounting Principles Board, the predecessor to the Financial
Accounting Standards Board (FASB), issued APB 25. The rule specified that the cost of options at the grant date should be measured by their
intrinsic value—the difference between the current fair market value of the stock and the exercise price of the option. Under this method, no
cost was assigned to options when their exercise price was set at the current market price.
The rationale for the rule was fairly simple: Because no cash changes hands when the grant is made, issuing a stock option is not an
economically significant transaction. That’s what many thought at the time. What’s more, little theory or practice was available in 1972 to guide
companies in determining the value of such untraded financial instruments.
APB 25 was obsolete within a year. The publication in 1973 of the Black-Scholes formula triggered a huge boom in markets for publicly traded
options, a movement reinforced by the opening, also in 1973, of the Chicago Board Options Exchange. It was surely no coincidence that the
growth of the traded options markets was mirrored by an increasing use of share option grants in executive and employee compensation. The
National Center for Employee Ownership estimates that nearly 10 million employees received stock options in 2000; fewer than 1 million did in
1990. It soon became clear in both theory and practice that options of any kind were worth far more than the intrinsic value defined by APB 25.
FASB initiated a review of stock option accounting in 1984 and, after more than a decade of heated controversy, finally issued SFAS 123 in
October 1995. It recommended—but did not require—companies to report the cost of options granted and to determine their fair market value
using option-pricing models. The new standard was a compromise, reflecting intense lobbying by businesspeople and politicians against
mandatory reporting. They argued that executive stock options were one of the defining components in America’s extraordinary economic
renaissance, so any attempt to change the accounting rules for them was an attack on America’s hugely successful model for creating new
businesses. Inevitably, most companies chose to ignore the recommendation that they opposed so vehemently and continued to record only
the intrinsic value at grant date, typically zero, of their stock option grants.
Subsequently, the extraordinary boom in share prices made critics of option expensing look like spoilsports. But since the crash, the debate has
returned with a vengeance. The spate of corporate accounting scandals in particular has revealed just how unreal a picture of their economic
performance many companies have been painting in their financial statements. Increasingly, investors and regulators have come to recognize
that option-based compensation is a major distorting factor. Had AOL Time Warner in 2001, for example, reported employee stock option
expenses as recommended by SFAS 123, it would have shown an operating loss of about $1.7 billion rather than the $700 million in operating
income it actually reported.
We believe that the case for expensing options is overwhelming, and in the following pages we examine and dismiss the principal claims put
forward by those who continue to oppose it. We demonstrate that, contrary to these experts’ arguments, stock option grants have real cashflow implications that need to be reported, that the way to quantify those implications is available, that footnote disclosure is not an acceptable
substitute for reporting the transaction in the income statement and balance sheet, and that full recognition of option costs need not
emasculate the incentives of entrepreneurial ventures. We then discuss just how firms might go about reporting the cost of options on their
income statements and balance sheets.
Fallacy 1: Stock Options Do Not Represent a Real Cost
It is a basic principle of accounting that financial statements should record economically significant transactions. No one doubts that traded
options meet that criterion; billions of dollars’ worth are bought and sold every day, either in the over-the-counter market or on exchanges. For
many people, though, company stock option grants are a different story. These transactions are not economically significant, the argument
goes, because no cash changes hands. As former American Express CEO Harvey Golub put it in an August 8, 2002, Wall Street Journal article,
stock option grants “are never a cost to the company and, therefore,
should never be recorded as a cost on the income statement.”
That position defies economic logic, not to mention common sense, in several respects. For a start, transfers of value do not have to involve
transfers of cash. While a transaction involving a cash receipt or payment is sufficient to generate a recordable transaction, it is not necessary.
Events such as exchanging stock for assets, signing a lease, providing future pension or vacation benefits for current period employment, or
acquiring materials on credit all trigger accounting transactions because they involve transfers of value, even though no cash changes hands at
the time the transaction occurs.
Even if no cash changes hands, issuing stock options to employees incurs a sacrifice of cash, an opportunity cost, which needs to be accounted
for. If a company were to grant stock, rather than options, to employees, everyone would agree that the company’s cost for this transaction
would be the cash it otherwise would have received if it had sold the shares at the current market price to investors. It is exactly the same with
stock options. When a company grants options to employees, it forgoes the opportunity to receive cash from underwriters who could take
these same options and sell them in a competitive options market to investors. Warren Buffett made this point graphically in an April 9, 2002,
Washington Post column when he stated: “Berkshire [Hathaway] will be happy to receive options in lieu of cash for many of the goods and
services that we sell corporate America.” Granting options to employees rather than selling them to suppliers or investors via underwriters
involves an actual loss of cash to the firm.
It can, of course, be more reasonably argued that the cash forgone by issuing options to employees, rather than selling them to investors, is
offset by the cash the company conserves by paying its employees less cash. As two widely respected economists, Burton G. Malkiel and William
J. Baumol, noted in an April 4, 2002, Wall Street Journal article: “A new, entrepreneurial firm may not be able to provide the cash compensation
needed to attract outstanding workers. Instead, it can offer
stock options.” But Malkiel and Baumol, unfortunately, do not follow their observation to its logical conclusion. For if the cost of stock options is
not universally incorporated into the measurement of net income, companies that grant options will underreport compensation costs, and it
won’t be possible to compare their profitability, productivity, and return-on-capital measures with those of economically equivalent companies
that have merely structured their compensation system in a different way. The following hypothetical illustration shows how that can happen.
Imagine two companies, KapCorp and MerBod, competing in exactly the same line of business. The two differ only in the structure of their
employee compensation packages. KapCorp pays its workers $400,000 in total compensation in the form of cash during the year. At the
beginning of the year, it also issues, through an underwriting, $100,000 worth of options in the capital market, which cannot be exercised for
one year, and it requires its employees to use 25% of their compensation to buy the newly issued options. The net cash outflow to KapCorp is
$300,000 ($400,000 in compensation expense less $100,000 from the sale of the options).
MerBod’s approach is only slightly different. It pays its workers $300,000 in cash and issues them directly $100,000 worth of options at the start
of the year (with the same one-year exercise restriction). Economically, the two positions are identical. Each company has paid a total of
$400,000 in compensation, each has issued $100,000 worth of options, and for each the net cash outflow totals $300,000 after the cash received
from issuing the options is subtracted from the cash spent on compensation. Employees at both companies are holding the same $100,000 of
options during the year, producing the same motivation, incentive, and retention effects.
How legitimate is an accounting standard that allows two
economically identical transactions to produce radically different
numbers?
In preparing its year-end statements, KapCorp will book compensation expense of $400,000 and will show $100,000 in options on its balance
sheet in a shareholder equity account. If the cost of stock options issued to employees is not recognized as an expense, however, MerBod will
book a compensation expense of only $300,000 and not show any options issued on its balance sheet. Assuming otherwise identical revenues
and costs, it will look as though MerBod’s earnings were $100,000 higher than KapCorp’s. MerBod will also seem to have a lower equity base
than KapCorp, even though the increase in the number of shares outstanding will eventually be the same for both companies if all the options
are exercised. As a result of the lower compensation expense and lower equity position, MerBod’s performance by most analytic measures will
appear to be far superior to KapCorp’s. This distortion is, of course, repeated every year that the two firms choose the different forms of
compensation. How legitimate is an accounting standard that allows two economically identical transactions to produce radically different
numbers?
Fallacy 2: The Cost of Employee Stock Options Cannot
Be Estimated
Some opponents of option expensing defend their position on practical, not conceptual, grounds. Option-pricing models may work, they say, as
a guide for valuing publicly traded options. But they can’t capture the value of employee stock options, which are private contracts between the
company and the employee for illiquid instruments that cannot be freely sold, swapped, pledged as collateral, or hedged.
It is indeed true that, in general, an instrument’s lack of liquidity will reduce its value to the holder. But the holder’s liquidity loss makes no
difference to what it costs the issuer to create the instrument unless the issuer somehow benefits from the lack of liquidity. And for stock
options, the absence of a liquid market has little effect on their value to the holder. The great beauty of option-pricing models is that they are
based on the characteristics of the underlying stock. That’s precisely why they have contributed to the extraordinary growth of options markets
over the last 30 years. The Black-Scholes price of an option equals the value of a portfolio of stock and cash that is managed dynamically to
replicate the payoffs to that option. With a completely liquid stock, an otherwise unconstrained investor could entirely hedge an option’s risk
and extract its value by selling short the replicating portfolio of stock and cash. In that case, the liquidity discount on the option’s value would
be minimal. And that applies even if there were no market for trading the option directly. Therefore, the liquidity—or lack thereof—of markets in
stock options does not, by itself, lead to a discount in the option’s value to the holder.
Investment banks, commercial banks, and insurance companies have now gone far beyond the basic, 30-year-old Black-Scholes model to
develop approaches to pricing all sorts of options: Standard ones. Exotic ones. Options traded through intermediaries, over the counter, and on
exchanges. Options linked to currency fluctuations. Options embedded in complex securities such as convertible debt, preferred stock, or
callable debt like mortgages with prepay features or interest rate caps and floors. A whole subindustry has developed to help individuals,
companies, and money market managers buy and sell these complex securities. Current financial technology certainly permits firms to
incorporate all the features of employee stock options into a pricing model. A few investment banks will even quote prices for executives
looking to hedge or sell their stock options prior to vesting, if their company’s option plan allows it.
Of course, formula-based or underwriters’ estimates about the cost of employee stock options are less precise than cash payouts or share
grants. But financial statements should strive to be approximately right in reflecting economic reality rather than precisely wrong. Managers
routinely rely on estimates for important cost items, such as the depreciation of plant and equipment and provisions against contingent
liabilities, such as future environmental cleanups and settlements from product liability suits and other litigation. When calculating the costs of
employees’ pensions and other retirement benefits, for instance, managers use actuarial estimates of future interest rates, employee retention
rates, employee retirement dates, the longevity of employees and their spouses, and the escalation of future medical costs. Pricing models and
extensive experience make it possible to estimate the cost of stock options issued in any given period with a precision comparable to, or greater
than, many of these other items that already appear on companies’ income statements and balance sheets.
Not all the objections to using Black-Scholes and other option valuation models are based on difficulties in estimating the cost of options
granted. For example, John DeLong, in a June 2002 Competitive Enterprise Institute paper entitled “The Stock Options Controversy and the New
Economy,” argued that “even if a value were calculated according to a model, the calculation would require adjustment to reflect the value to
the employee.” He is only half right. By paying employees with its own stock or options, the company forces them to hold highly non-diversified
financial portfolios, a risk further compounded by the investment of the employees’ own human capital in the company as well. Since almost all
individuals are risk averse, we can expect employees to place substantially less value on their stock option package than other, betterdiversified, investors would.
Estimates of the magnitude of this employee risk discount—or “deadweight cost,” as it is sometimes called—range from 20% to 50%,
depending on the volatility of the underlying stock and the degree of diversification of the employee’s portfolio. The existence of this
deadweight cost is sometimes used to justify the apparently huge scale of option-based remuneration handed out to top executives. A
company seeking, for instance, to reward its CEO with $1 million in options that are worth $1,000 each in the market may (perhaps perversely)
reason that it should issue 2,000 rather than 1,000 options because, from the CEO’s perspective, the options are worth only $500 each. (We
would point out that this reasoning validates our earlier point that options are a substitute for cash.)
But while it might arguably be reasonable to take deadweight cost into account when deciding how much equity-based compensation (such as
options) to include in an executive’s pay packet, it is certainly not reasonable to let dead-weight cost influence the way companies record the
costs of the packets. Financial statements reflect the economic perspective of the company, not the entities (including employees) with which it
transacts. When a company sells a product to a customer, for example, it does not have to verify what the product is worth to that individual. It
counts the expected cash payment in the transaction as its revenue. Similarly, when the company purchases a product or service from a supplier,
it does not examine whether the price paid was greater or less than the supplier’s cost or what the supplier could have received had it sold the
product or service elsewhere. The company records the purchase price as the cash or cash equivalent it sacrificed to acquire the good or service.
Suppose a clothing manufacturer were to build a fitness center for its employees. The company would not do so to compete with fitness clubs.
It would build the center to generate higher revenues from increased productivity and creativity of healthier, happier employees and to reduce
costs arising from employee turnover and illness. The cost to the company is clearly the cost of building and maintaining the facility, not the
value that the individual employees might place on it. The cost of the fitness center is recorded as a periodic expense, loosely matched to the
expected revenue increase and reductions in employee-related costs.
The only reasonable justification we have seen for costing executive options below their market value stems from the observation that many
options are forfeited when employees leave, or are exercised too early because of employees’ risk aversion. In these cases, existing shareholders’
equity is diluted less than it would otherwise be, or not at all, consequently reducing the company’s compensation cost. While we agree with the
basic logic of this argument, the impact of forfeiture and early exercise on theoretical values may be grossly exaggerated. (See “The Real Impact
of Forfeiture and Early Exercise” at the end of this article.)
Fallacy 3: Stock Option Costs Are Already Adequately
Disclosed
Another argument in defense of the existing approach is that companies already disclose information about the cost of option grants in the
footnotes to the financial statements. Investors and analysts who wish to adjust income statements for the cost of options, therefore, have the
necessary data readily available. We find that argument hard to swallow. As we have pointed out, it is a fundamental principle of accounting that
the income statement and balance sheet
by exercising vested stock options much earlier than a well-diversified investor would, thereby reducing the potential for a much higher payoff
had they held the options to maturity. Employees with vested options that are in the money will also exercise them when they quit, since most
companies require employees to use or lose their options upon departure. In both cases, the economic impact on the company of issuing the
options is reduced, since the value and relative size of existing shareholders’ stakes are diluted less than they could have been, or not at all.
Recognizing the increasing probability that companies will be required to expense stock options, some opponents are fighting a rearguard
action by trying to persuade standard setters to significantly reduce the reported cost of those options, discounting their value from that
measured by financial models to reflect the strong likelihood of forfeiture and early exercise. Current proposals put forth by these people to
FASB and IASB would allow companies to estimate the percentage of options forfeited
should portray a company’s underlying economics. Relegating an item of such major economic significance as employee option grants to the
footnotes would systematically distort those reports.
But even if we were to accept the principle that footnote disclosure is sufficient, in reality we would find it a poor substitute for recognizing the
expense directly on the primary statements. For a start, investment analysts, lawyers, and regulators now use electronic databases to calculate
profitability ratios based on the numbers in companies’ audited income statements and balance sheets. An analyst following an individual
company, or even a small group of companies, could make adjustments for information disclosed in footnotes. But that would be difficult and
costly to do for a large group of companies that had put different sorts of data in various nonstandard formats into footnotes. Clearly, it is much
easier to compare companies on a level playing field, where all compensation expenses have been incorporated into the income numbers.
during the vesting period and reduce the cost of option grants by this amount. Also, rather than use the expiration date for the option life in an
option-pricing model, the proposals seek to allow companies to use an expected life for the option to reflect the likelihood of early exercise.
Using an expected life (which companies may estimate at close to the vesting period, say, four years) instead of the contractual period of, say,
ten years, would significantly reduce the estimated cost of the option.
Some adjustment should be made for forfeiture and early exercise. But the proposed method significantly overstates the cost reduction since it
neglects the circumstances under which options are most likely to be forfeited or exercised early. When these circumstances are taken into
account, the reduction in employee option costs is likely to be much smaller.
First, consider forfeiture. Using a flat percentage for forfeitures based on historical or prospective employee turnover is valid only if forfeiture is
a random event, like a lottery,
What’s more, numbers divulged in footnotes can be less reliable than those disclosed in the primary financial statements. For one thing,
executives and auditors typically review supplementary footnotes last and devote less time to them than they do to the numbers in the primary
statements. As just one example, the footnote in eBay’s FY 2000 annual report reveals a “weighted average grant date fair value of options
granted during 1999 of $105.03” for a year in which the weighted average exercise price of shares granted was $64.59. Just how the value of
options granted can be 63% more than the value of the underlying stock is not obvious. In FY 2000, the same effect was reported: a fair value of
options granted of $103.79 with an average exercise price of $62.69. Apparently, this error was finally detected, since the FY 2001 report
retroactively adjusted the 1999 and 2000 average grant-date fair values to $40.45 and $41.40, respectively. We believe executives and auditors
will exert greater diligence and care in obtaining reliable estimates of the cost of stock options if these figures are included in companies’
income statements than they currently
independent of the stock price. In reality, however, the likelihood of forfeiture is negatively related to the value of the options forfeited and,
hence, to the stock price itself. People are more likely to leave a company and forfeit options when the stock price has declined and the options
are worth little. But if the firm has done well and the stock price has increased significantly since grant date, the options will have become much
more valuable, and employees will be much less likely to leave. If employee turnover and forfeiture are more likely when the options are least
valuable, then little of the options’ total cost at grant date is reduced because of the probability of forfeiture.
The argument for early exercise is similar. It also depends on the future stock price. Employees will tend to exercise early if most of their wealth
is bound up in the company, they need to diversify, and they have no other way to reduce their risk exposure to the company’s stock price.
Senior executives, however, with the largest option holdings, are unlikely to exercise early and destroy option value when the stock price
do for footnote disclosure.
Our colleague William Sahlman in his December 2002 HBR article, “Expensing Options Solves Nothing,” has expressed concern that the wealth
of useful information contained in the footnotes about the stock options granted would be lost if options were expensed. But surely recognizing
the cost of options in the income statement does not preclude continuing to provide a footnote that explains the underlying distribution of
grants and the methodology and parameter inputs used to calculate the cost of the stock options.
Some critics of stock option expensing argue, as venture capitalist John Doerr and FedEx CEO Frederick Smith did in an April 5, 2002, New York
Times column, that “if expensing were … required, the impact of options would be counted twice in the earnings per share: first as a potential
dilution of the earnings, by increasing the shares outstanding, and second as a charge
has risen substantially. Often they own unrestricted stock, which they can sell as a more efficient means to reduce their risk exposure. Or they
have enough at stake to contract with an investment bank to hedge their option positions without exercising prematurely. As with the forfeiture
feature, the calculation of an expected option life without regard to the magnitude of the holdings of employees who exercise early, or to their
ability to hedge their risk through other means, would significantly underestimate the cost of options granted.
Option-pricing models can be modified to incorporate the influence of stock prices and the magnitude of employees’ option and stock holdings
on the probabilities of forfeiture and early exercise. (See, for example, Mark Rubinstein’s Fall 1995 article in the Journal of Derivatives, “On the
Accounting Valuation of Employee Stock Options.”) The actual magnitude of these adjustments needs to be based on specific company data,
such as stock price appreciation and distribution of option grants among employees. The adjustments, properly assessed,
against reported earnings. The result would be inaccurate and misleading earnings per share.”
We have several difficulties with this argument. First, option costs only enter into a (GAAP-based) diluted earnings per-share calculation when
the current market price exceeds the option exercise price. Thus, fully diluted EPS numbers still ignore all the costs of options that are nearly in
the money or could become in the money if the stock price increased significantly in the near term.
Second, relegating the determination of the economic impact of stock option grants solely to an EPS calculation greatly distorts the
measurement of reported income, would not be adjusted to reflect the economic impact of option costs. These measures are more significant
summaries of the change in economic value of a company than the prorated distribution of this income to individual shareholders revealed in
the EPS measure. This becomes eminently clear when taken to its logical absurdity: Suppose companies were to compensate
all their suppliers—of materials, labor, energy, and purchased services—with stock options rather than with cash and avoid all expense
recognition in their income statement. Their income and their profitability measures would all be so grossly inflated as to be useless for analytic
purposes; only the EPS number would pick up any economic effect from the option grants.
Our biggest objection to this spurious claim, however, is that even a calculation
of fully diluted EPS does not fully reflect the economic impact of stock option grants. The following hypothetical example illustrates the
problems, though for purposes of simplicity we will use grants of shares instead of options. The reasoning is exactly the same for both cases.
Let’s say that each of our two hypothetical companies, KapCorp and MerBod, has 8,000 shares outstanding, no debt, and annual revenue this
year of $100,000. KapCorp decides to pay its employees and suppliers $90,000 in cash and has no other expenses. MerBod, however,
compensates its employees and suppliers with $80,000 in cash and 2,000 shares of stock, at an average market price of $5 per share. The cost to
each company is the same: $90,000. But their net income and EPS numbers are very different. KapCorp’s net income before taxes is $10,000, or
$1.25 per share. By contrast, MerBod’s reported net income (which ignores the cost of the equity granted to employees and suppliers) is
$20,000, and its EPS is $2.00 (which takes into account the new shares issued).
Of course, the two companies now have different cash balances and numbers of shares outstanding with a claim on them. But KapCorp can
eliminate that discrepancy by issuing 2,000 shares of stock in the market during the year at an average selling price of $5 per share. Now both
companies have closing cash balances of $20,000 and 10,000 shares outstanding. Under current accounting rules, however, this transaction only
exacerbates the gap between the EPS numbers. KapCorp’s reported income remains $10,000, since the additional $10,000 value gained from the
sale of the shares is not reported in net income, but its EPS denominator has increased from 8,000 to 10,000. Consequently, KapCorp now
reports an EPS of $1.00 to MerBod’s $2.00, even though their economic positions are identical: 10,000 shares outstanding and increased cash
balances of $20,000. The people claiming that options expensing creates a double-counting problem are themselves creating a smoke screen to
hide the income-distorting effects of stock option grants.
The people claiming that options expensing creates a doublecounting problem are themselves creating a smoke screen to hide the
income-distorting effects of stock option grants.
Indeed, if we say that the fully diluted EPS figure is the right way to disclose the impact of share options, then we should immediately change
the current accounting rules for situations when companies issue common stock, convertible preferred stock, or convertible bonds to pay for
services or assets. At present, when these transactions occur, the cost is measured by the fair market value of the consideration involved. Why
should options be treated differently?
Fallacy 4: Expensing Stock Options Will Hurt Young
Businesses
Opponents of expensing options also claim that doing so will be a hardship for entrepreneurial high-tech firms that do not have the cash to
attract and retain the engineers and executives who translate entrepreneurial ideas into profitable, long term growth.
This argument is flawed on a number of levels. For a start, the people who claim that option expensing will harm entrepreneurial incentives are
often the same people who claim that current disclosure is adequate for communicating the economics of stock option grants. The two
positions are clearly contradictory. If current disclosure is sufficient, then moving the cost from a footnote to the balance sheet and income
statement will have no market effect. But to argue that proper costing of stock options would have a significant adverse impact on companies
that make extensive use of them is to admit that the economics of stock options, as currently disclosed in footnotes, are not fully reflected in
companies’ market prices.
More seriously, however, the claim simply ignores the fact that a lack of cash need not be a barrier to compensating executives. Rather than
issuing options directly to employees, companies can always issue them to underwriters and then pay their employees out of the money
received for those options. Considering that the market systematically puts a higher value on options than employees do, companies are likely
to end up with more cash from the sale of externally issued options (which carry with them no deadweight costs) than they would by granting
options to employees in lieu of higher salaries.
Even privately held companies that raise funds through angel and venture capital investors can take this approach. The same procedures used
to place a value on a privately held company can be used to estimate the value of its options, enabling
external investors to provide cash for options about as readily as they provide cash for stock.
That’s not to say, of course, that entrepreneurs should never get option grants. Venture capital investors will always want employees to be
compensated with some stock options in lieu of cash to be assured that the employees have some “skin in the game” and so are more likely to
be honest when they tout their company’s prospects to providers of new capital. But that does not preclude also raising cash by selling options
externally to pay a large part of the cash compensation to employees.
We certainly recognize the vitality and wealth that entrepreneurial ventures, particularly those in the high-tech sector, bring to the U.S.
economy. A strong case can be made for creating public policies that actively assist these companies in their early stages, or even in their more
established stages. The nation should definitely consider a regulation that makes entrepreneurial, job-creating companies healthier and more
competitive by changing something as simple as an accounting journal entry.
But we have to question the effectiveness of the current rule, which essentially makes the benefits from a deliberate accounting distortion
proportional to companies’ use of one particular form of employee compensation. After all, some entrepreneurial, job-creating companies
might benefit from picking other forms of incentive compensation that arguably do a better job of aligning executive and shareholder interests
than conventional stock options do. Indexed or performance options, for example, ensure that management is not rewarded just for being in
the right place at the right time or penalized just for being in the wrong place at the wrong time. A strong case can also be made for the
superiority of properly designed restricted stock grants and deferred cash payments. Yet current
accounting standards require that these, and virtually all other compensation alternatives, be expensed. Are companies that choose those
alternatives any less deserving of an accounting subsidy than Microsoft, which, having granted 300 million options in 2001 alone, is by far the
largest issuer of stock options?
A less distorting approach for delivering an accounting subsidy to entrepreneurial ventures would simply be to allow them to defer some
percentage of their total employee compensation for some number of years, which could be indefinitely— just as companies granting stock
options do now. That way, companies could get the supposed accounting benefits from not having to report a portion of their compensation
costs no matter what form that compensation might take.
What Will Expensing Involve?
Although the economic arguments in favor of reporting stock option grants on the principal financial statements seem to us to be
overwhelming, we do recognize that expensing poses challenges. For a start, the benefits accruing to the company from issuing stock options
occur in future periods, in the form of increased cash flows generated by its option motivated and retained employees. The fundamental
matching principle of accounting requires that the costs of generating those higher revenues be recognized at the same time the revenues are
recorded. This is why companies match the cost of multiperiod assets such as plant and equipment with the revenues these assets produce over
their economic lives.
In some cases, the match can be based on estimates of the future cash flows. In expensing capitalized software-development costs, for instance,
managers match the costs against a predicted pattern of benefits accrued from selling the software. In the case of options, however, managers
would have to estimate an equivalent pattern of benefits arising from their own decisions and activities. That would likely introduce significant
measurement error and provide opportunities for
managers to bias their estimates. We therefore believe that using a standard straight-line amortization formula will reduce measurement error
and management bias despite some loss of accuracy. The obvious period for the amortization is the useful economic life of the granted option,
probably best measured by the vesting period. Thus, for an option vesting in four years, 1/48 of the cost of the option would be expensed
through the income statement in each month until the option vests. This would treat employee option compensation costs the same way the
costs of plant and equipment or inventory are treated when they are acquired through equity instruments, such as in an acquisition.
In addition to being reported on the income statement, the option grant should also appear on the balance sheet. In our opinion, the cost of
options issued represents an increase in shareholders’ equity at the time of grant and should be reported as paid-in capital. Some experts argue
that stock options are more like contingent liability than equity transactions since their ultimate cost to the company cannot be determined until
employees either exercise or forfeit their options. This argument, of course, ignores the considerable economic value the company has sacrificed
at time of grant. What’s more, a contingent liability is usually recognized as an expense when it is possible to estimate its value and the liability
is likely to be incurred. At time of grant, both these conditions are met. The value transfer is not just probable; it is certain. The company has
granted employees an equity security that could have been issued to investors and suppliers who would have given cash, goods, and services in
return. The amount sacrificed can also be estimated, using option-pricing models or independent estimates from investment banks.
There has to be, of course, an offsetting entry on the asset side of the balance sheet. FASB, in its exposure draft on stock option accounting in
1994, proposed that at time of grant an asset called “prepaid compensation expense” be recognized, a
recommendation we endorse. FASB, however, subsequently retracted its proposal in the face of criticism that since employees can quit at any
time, treating their deferred compensation as an asset would violate the principle that a company must always have legal control over the assets
it reports. We feel that FASB capitulated too easily to this argument. The firm does have an asset because of the option grant —presumably a
loyal, motivated employee. Even though the firm does not control the asset in a legal sense, it does capture the benefits. FASB’s concession on
this issue subverted substance to form.
Finally, there is the issue of whether to allow companies to revise the income number they’ve reported after the grants have been issued. Some
commentators argue that any recorded stock option compensation expense should be reversed if employees forfeit the options by leaving the
company before vesting or if their options expire unexercised. But if companies were to mark compensation expense downward when
employees forfeit their options, should they not also mark it up when the share price rises, thereby increasing the market value of the options?
Clearly, this can get complicated, and it comes as no surprise that neither FASB nor IASB recommends any kind of postgrant accounting
revisions, since that would open up the question of whether to use mark-to-market accounting for all types of assets and liabilities, not just
share options. At this time, we don’t have strong feelings about whether the benefits from mark-to-market accounting for stock options exceed
the costs. But we would point out that people who object to estimating the cost of options granted at time of issue should be even less
enthusiastic about reestimating their options’ cost each quarter.• • •
We recognize that options are a powerful incentive, and we believe that all companies should consider them in deciding how to attract and
retain talent and align the interests of managers and owners. But we also believe that failing to record a transaction that creates such powerful
effects is economically indefensible
and encourages companies to favor options over alternative compensation methods. It is not the proper role of accounting standards to distort
executive and employee compensation by subsidizing one form of compensation relative to all others. Companies should choose compensation
methods according to their economic benefits—not the way they are reported.
It is not the proper role of accounting standards to distort executive
and employee compensation by subsidizing one form of
compensation relative to all others.
A version of this article appeared in the March 2003 issue of Harvard Business Review.
Zvi Bodie is a professor of finance at Boston University’s School of Management.
Robert S. Kaplan is a senior fellow and the Marvin Bower Professor of
Leadership Development, Emeritus, at Harvard Business School. His most recent
HBR articles include: “Inclusive Growth: Profitable Strategies for Tackling
Poverty and Inequality” (with George Serafeim and Eduardo Tugendhat), “How
to Pay for Health Care: The Case for Bundled Payments” (with Michael E.
Porter), and “How to Solve the
Cost Crisis in Health Care” (with Michael E. Porter).
Robert C. Merton, a recipient of the 1997 Alfred Nobel Memorial Prize in Economic Sciences, is the School of Management Distinguished
Professor of Finance at the MIT Sloan School of Management. He is also the resident scientist at Dimensional Fund Advisors, a Texas-based
global asset management firm, and University Professor Emeritus at Harvard University.
June 30, 2004
Director of Major Projects Financial Accounting Standards Board 401 Merritt 7 POBox 5116 Norwalk, CT 06856-5116
Re: File Reference 1102-100
Dear Sir or Madam:
We appreciate the opportunity to comment on your Exposure Draft, entitled “Share-Based
Payment – an amendment of Statements No.1 23 and 95” (the “Exposure Draft”). We believe the Exposure Draft deviates from FASB’s stated
objectives of establishing accounting and reporting standards that provide credible, concise, transparent and understandable financial
information that is consistent among enterprises. We strongly agree with those stated objectives, and accordingly, we do not agree with the
proposal to expense employee stock options as outlined in the Exposure Draft.
Our primary concerns with the Exposure Draft can be summarized as
follows:
Employee stock options granted at market price do not constitute an “expense” under present accounting definitions, do not represent an
economic cost to the issuer and should not be recognized as a compensation expense of the issuing company.
The measurement methodologies and tools recommended by FA SB rely significantly on management judgments and estimates and will
lead to a lack of consistency and comparability among reported results.
FA SB should implement a plan for comprehensive field testing, before adopting any new standards, to gain an adequate understanding of
the range of practical issues arising from the measures outlined in the Exposure Draft.
Each of these concerns is examined in greater detail below.
Employee Stock Options are Not an Expense
Micron strongly disagrees with FA SB’ s conclusion that issuance of equity instruments in
exchange for employee services give rise to recognizable compensation costs of the issuing company.
Wc believe the fundamental objectives of financial reporting center around providing
infonnation about an enterprise’s economic resources, obligations and owners’ equity. FASB Statement of Concepts No. I, states “Over the life of
an enterprise (or other very long period), total reported earnings equals the net cash receipts excluding those from capital…” Furthermore, FA SB
Statement of Concepts No.6, states “Expenses represent actual or expected cash outflows (or the equivalent) that have occurred or will
eventuate as a result of the entity’s ongoing major or central operations.” (We note the accrual method of accounting is used to allow for
differences between the timing of the effects on results of operations and the actual flow of cash.) The conceptual relationship between a
company’s long-term results of operations and its cumulative cash flows is fundamental to investors’ valuations. The proposed mandatory
expense recognition for employee stock options represents a hypothetical expense for which there is no current or future cash flow. This would
result in a permanent difference between a company’s results of operations and the actual or expected cash flows, and necessitates investors’
adjustment of the expense the Exposure Draft requires.
The Exposure Draft’s stock option expense that results is truly unique in accounting in
that there is never a “true-up” of the estimate. Because option lives and the volatilities oflonglived, non transferable employee stock options are
not known at grant date and are subject to revision and refinement as actual events become known, the imperative to true-up an expense
couldn’t be higher.
It is not apparent how FASB reconciles the requirement to periodically
update all other estimates necessitated by generally accepted accounting principles, and ignore adjusting this employee stock option expense.
The impact to a company as a result of the granting of employee stock options is the
dilution of shareholders, a cost which is already reflected in the computation of earnings per share. The dilution of shareholders’ equity is
reflected in the computation ofEPS by application of the Treasury Stock Method. To require expense recognition in addition to the ownership
dilution would effectively double-count employee stock options.
Valuation Methods Lead to Lack of Consistency and Comparability
The Exposure Draft’s proposed valuation methods will not provide a reasonable
approximation of the cost of employee stock options. Problems with using the proposed binomial or Black-Scholes option valuation methods to
value employee stock options have been well documented. Problems with the option valuation models can be summarized into three primary
categories:
I. The proposed option valuation models do not accurately estimate values of the shortterm, exchange traded stock options for which they
were designed.
II. The proposed valuation methods do not accurately address the significantly different characteristics oflong-term, employee stock options
which are not publicly traded.
3) The stock option valuation models are dependent on inputs that cannot be accurately estimated.
A number of empirical studies have questioned whether the valuation models can
accurately estimate values of the short-term, publicly traded stock options for which they were designed. Many researchers have challenged
whether the distribution of stock option prices is truly lognormal, a central tenet of the valuation models. Further, even for short-term exchange
traded options there are differences in opinion on how critical volatility inputs should be measured. While we can not conclude that option
valuation models accurately estimate the value of short-term exchange traded options for which they were designed, there are even greater
problems when the valuation models are applied to employee stock options. Numerous problems with applying option valuation models to
employee stock options have been cited by academics and others. A fundamental problem is that employee stoek options generally are not
transferable or tradable so an employee can only realize value through an exercise which results in forfeiture of the option’s future time value.
Further, employee stock options are not hedgeable.
These
features make the employee stock options worth less than exchange traded options, but the proposed statement does not provide for a
discount, resulting in an inherent overstatement of compensation expense.
The proposed statement would also result in the overstatement of compensation expenses
related to employee stock options because the calculation methodologies do not adjust for the nature of employee stock awards.
Stock option awards are inherently worth less to an employee
than an external investors’ exchange traded options for the following reasons:
1. An employee’s risk tolerance cannot wholly align with the terms of the option award.
2. An employee’s liquidity needs vary over the life of an option award.
3. A typical employee does not have sufficient information or sophistication to properly value of the award, and thus there is a valuation
discount.
4. An employee’s diversification needs are not compatible with option awards.
For the aforementioned reasons, employees will not place the same value on their options as an external investor does on exchange traded
options. The proposed standard does not recognize this key difference, resulting in a systematic overstatement of employee stock awards.
The greatest problem with the proposed valuation method for employee stock options is
the inability to accurately determine input variables used in the model. Slight changes in the expected term of the option or the expected
volatility ofthe price of the underlying share have a dramatic effect on the value of the option yet there is no way to reliably estimate these
variables. For Micron, which has experienced historically high volatility and constantly changing exerCising patterns, utilization of two alternative
reasonable, supportable estimates of the model variables would result in a computed cost that varied by more than 100%. By the Exposure
Draft’s provisions, both of those results would meet the approximately right characterization, but would be virtually useless to the investment
community.
Micron has historically experienced dramatic changes in our operations and market. The following are examples of some of these changes:
In 1998 we acquired the operations of one of our major competitors, which more than doubled our manufacturing capacity, enabling us to
increase our market share in the DRAM industry from approximately 7% to approximately 20% in less than three years,
In 2000 we disposed of our PC operations, which had constituted more than 50% of our net revenue in fiscal year 1998.
We have pursued a number of new markets outside our core DRAM operations that could significantly change the nature of our business.
Our primary industry DRAM has cycled through severe imbalances in supply/demand relationships of our commodity product over the last
10 years leading to dramatic changes in our operating results and stock price.
The DRAM industry has also undergone a major consolidation with many firms exiting the business and a small number of companies
holding greater than 75% of market share.
The dramatic changes in our business resulting from the aforementioned and other
changes greatly diminish the likelihood that the historical volatility of the Company’s stock prices is representative of the future volatility of the
Company’s stock price. Factoring any changes into expected volatility is highly subjective at best and fraught with error. For example,
most
stability and less volatility in market pricing. Actual results over the past few years have been exactly the opposite as volatility increased.
outside analysts predicted that consolidation of the DRAM industry would lead
to greater
Accurately estimating the expected term of employee options is equally difficult.
Historical exercise behavior is dependent on a number of factors that are constantly changing such as the following:
Spikes and drops in our stock price which change employee perceptions of risk and return
ftheir stock options.
Recent success of the Company which alters employees’ personal financial position as a result ofthe Company’s compensation plans being
significantly variable.
Changes in the demographics ofthe Company’s employees which have become significantly more international and older as the Company
matures.
The average term of the Company’s employee stock options has varied substantially in
recent periods due to market conditions and changes in behavioral factors. There is no reliable method to estimate the affect of changes in
bchavioral factors on the expected term for employee options.
Under the proposed statement, a company’s ability to accurately estimate the variables
required in stock options valuation model would be severely constrained. Paragraph B17, of the proposed standard asserts that “Data and
assumptions used to estimate the fair value of equity and liability instruments granted to employees should be determined in a consistent
manner from period to period.” To avoid the appearance of being inconsistent or of manipulating earnings companies will likely avoid the
subjective and difficult adjustments to variables that are necessary to accurately reflect real changes in current conditions. The Exposure Draft
creates a very significant dilemma for an issuer.
Adjustments to how model inputs are estimated could
ereate issues with independent auditors and subject the company to increased litigation risk.
It is our position that a flawed valuation model based on inaccurate variables will not
result in a reasonable approximation of the cost of employee stock options. We strongly disagree with the Board’s contention that for employee
stock options it is better to record a cost that is “approximately right” than to not record any cost for several reasons:
I. Recording transactions based on uureliable data gives the impression that the information has much greater precision than it does.
II. Based on reasonable estimates of data inputs there is little confidence that the calculated cost of stock awards is closer to the actual value
of the award than a $0 value.
III. Unlike other cost accruals which merely allocate expenses between periods, stock
ption valuation result in estimation differences that are permanent and never reconciled.
IV. The valuation method in the proposed standard results in a systematic overstatement
f compensation expense by failing to account for certain differences between employee and exchange traded options.
Need for Field Testing
As is evidenced by the overwhelming response to the Exposure Draft from business leaders,
financial experts, investor activists, academicians and the media, there is no consensus on what constitutes appropriate treatment of employee
stock options. In order to achieve a workable consensus we believe it is imperative that FA SB implement rigorous and widespread field testing
before any new standards are adopted. To be effective any such field testing must include companies that range from large multinationals to
small domestic start-ups. Widespread field testing would provide FA SB with a forum for identifying, understanding and addressing the practical
challenges and implications of the proposed standards.
We understand that FA SB has
successfully used this type of field testing in the past and encourage you to do so again.
****
Thank you for giving us the opportunity to comment on the Exposure Draft. If you have
any questions or need any additional information from us as you deliberate your course of action, please do not hesitate to contact me at (208)
368-4621.
Very truly yours,
/s/ W. G. STOVER, JR.
W.G. Stover, Jr. Vice President of Finance and Chief Financial Officer
ce: Director@fasb.org
ACTG 493
Professor Balachandran
ACTG 493, SPRING 2024
INDIVIDUAL ASSIGNMENT #4
DUE: THURSDAY MARCH 7
As part of its due process, the Financial Accounting Standards Board (FASB) gathers feedback on its
proposed standards. In many cases the organizations or persons responding provide useful information
because they provide a viewpoint the FASB has not fully considered or else provide technical information
about a particular industry or practice the FASB has failed to consider.

In this assignment, you will learn some basic background about what an employee stock option is, how it
works. With that background information you are going to evaluate the arguments raised by the CFO of
Micron Technology in his letter providing feedback to the FASB on the proposed standard on share-based
payments that later was finalized as SFAS 123R, Share-Based Payments. SFAS 123R, later codified as
ASC 718, requires companies to recognize expenses using the fair value of the stock options granted to
executives and employees.

Required:
Read the first three pages of the of the article “How do employee stock options work,” by Samuel Deane
of Morningstar. Then read the comment letter from Micorn’s CFO. Write a memo using the format in
the Memo Guidelines to address the following three questions:

1. Briefly describe what an employee stock option is and how it works? Why might an employer want
to use employee stock options, vs other forms of compensation? Why might employees want
employee stock options, vs other forms of compensation?

2. The first two logical arguments raised by Micron by the main points of their memo are:

a. Employee stock options granted at market price do not constitute an “expense” under present
accounting definitions, do not represent an economic cost to the issuer and should not be
recognized as a compensation expense of the issuing company.

b. The measurement methodologies and tools recommended by FASB rely significantly on
management judgments and estimates and will lead to a lack of consistency and
comparability among reported results.

Do the principles in the FASB’s conceptual framework lead you to agree or disagree with each of
these two arguments raised by Micron? Discuss each argument separately, identify relevant aspects
of the conceptual framework that you believe are relevant to the arguments being made by Micron.
Be sure to explain why the conceptual framework supports or contradicts the arguments being made
by Micron.

3. Based on your general understanding of the FASB’s conceptual framework and the debate over
expensing stock-based compensation, would you support or oppose to FASB’s requirement of
recognizing stock-based compensation expense measured using fair value? Explain your answer and
provide justification for your views. Be sure to draw from the various aspects of the conceptual
framework.
There is not necessarily right or wrong answer to each question. Express your opinion and back them up
with facts and reasoning, particularly reasoning based on the conceptual framework. Do some research
online. You can use all available literature as reference, including those listed below. Be sure to cite any
sources that you use to develop insights or provide direct quotes from (e.g., sections of the codification,
articles).
Your memo should be no more than four pages. You should use 12-point Times New Roman font, oneinch margin on all sides, double spacing in the main text and single spacing in the header.
You should submit your memo online through Blackboard by 9:00 a.m. on Thursday March 7, 2024
1
ACTG 493
Professor Balachandran
References (all can be found in the Assessment menu on Blackboard):
 Micron Comment Letter on FASB’s Proposed SFAS 123R, June 30, 2004
 Bode, Zvi, Kaplan, Robert, and Merton, Robert (2003), For the last time: Stock options are an
expense, Harvard Business Review
 Guay, Wayne, Kothari, S.P., and Sloan, Richard (2003), Accounting for employee stock options. The
American Economic Review, 93(2), 405-409.
 Allee, Kristian D., Maines, Laureen A., and Wood, David. A. (2008). Unintended economic
implications of financial reporting standards. Business Horizons, 51, 371-377.
2
June 30, 2004
Director of Major Projects Financial Accounting Standards Board 401 Merritt 7 POBox 5116 Norwalk, CT 06856-5116
Re: File Reference 1102-100
Dear Sir or Madam:
We appreciate the opportunity to comment on your Exposure Draft, entitled “Share-Based
Payment – an amendment of Statements No.1 23 and 95” (the “Exposure Draft”). We believe the Exposure Draft deviates from FASB’s stated
objectives of establishing accounting and reporting standards that provide credible, concise, transparent and understandable financial
information that is consistent among enterprises. We strongly agree with those stated objectives, and accordingly, we do not agree with the
proposal to expense employee stock options as outlined in the Exposure Draft.
Our primary concerns with the Exposure Draft can be summarized as
follows:
Employee stock options granted at market price do not constitute an “expense” under present accounting definitions, do not represent an
economic cost to the issuer and should not be recognized as a compensation expense of the issuing company.
The measurement methodologies and tools recommended by FA SB rely significantly on management judgments and estimates and will
lead to a lack of consistency and comparability among reported results.
FA SB should implement a plan for comprehensive field testing, before adopting any new standards, to gain an adequate understanding of
the range of practical issues arising from the measures outlined in the Exposure Draft.
Each of these concerns is examined in greater detail below.
Employee Stock Options are Not an Expense
Micron strongly disagrees with FA SB’ s conclusion that issuance of equity instruments in
exchange for employee services give rise to recognizable compensation costs of the issuing company.
Wc believe the fundamental objectives of financial reporting center around providing
infonnation about an enterprise’s economic resources, obligations and owners’ equity. FASB Statement of Concepts No. I, states “Over the life of
an enterprise (or other very long period), total reported earnings equals the net cash receipts excluding those from capital…” Furthermore, FA SB
Statement of Concepts No.6, states “Expenses represent actual or expected cash outflows (or the equivalent) that have occurred or will
eventuate as a result of the entity’s ongoing major or central operations.” (We note the accrual method of accounting is used to allow for
differences between the timing of the effects on results of operations and the actual flow of cash.) The conceptual relationship between a
company’s long-term results of operations and its cumulative cash flows is fundamental to investors’ valuations. The proposed mandatory
expense recognition for employee stock options represents a hypothetical expense for which there is no current or future cash flow. This would
result in a permanent difference between a company’s results of operations and the actual or expected cash flows, and necessitates investors’
adjustment of the expense the Exposure Draft requires.
The Exposure Draft’s stock option expense that results is truly unique in accounting in
that there is never a “true-up” of the estimate. Because option lives and the volatilities oflonglived, non transferable employee stock options are
not known at grant date and are subject to revision and refinement as actual events become known, the imperative to true-up an expense
couldn’t be higher.
It is not apparent how FASB reconciles the requirement to periodically
update all other estimates necessitated by generally accepted accounting principles, and ignore adjusting this employee stock option expense.
The impact to a company as a result of the granting of employee stock options is the
dilution of shareholders, a cost which is already reflected in the computation of earnings per share. The dilution of shareholders’ equity is
reflected in the computation ofEPS by application of the Treasury Stock Method. To require expense recognition in addition to the ownership
dilution would effectively double-count employee stock options.
Valuation Methods Lead to Lack of Consistency and Comparability
The Exposure Draft’s proposed valuation methods will not provide a reasonable
approximation of the cost of employee stock options. Problems with using the proposed binomial or Black-Scholes option valuation methods to
value employee stock options have been well documented. Problems with the option valuation models can be summarized into three primary
categories:
I. The proposed option valuation models do not accurately estimate values of the shortterm, exchange traded stock options for which they
were designed.
II. The proposed valuation methods do not accurately address the significantly different characteristics oflong-term, employee stock options
which are not publicly traded.
3) The stock option valuation models are dependent on inputs that cannot be accurately estimated.
A number of empirical studies have questioned whether the valuation models can
accurately estimate values of the short-term, publicly traded stock options for which they were designed. Many researchers have challenged
whether the distribution of stock option prices is truly lognormal, a central tenet of the valuation models. Further, even for short-term exchange
traded options there are differences in opinion on how critical volatility inputs should be measured. While we can not conclude that option
valuation models accurately estimate the value of short-term exchange traded options for which they were designed, there are even greater
problems when the valuation models are applied to employee stock options. Numerous problems with applying option valuation models to
employee stock options have been cited by academics and others. A fundamental problem is that employee stoek options generally are not
transferable or tradable so an employee can only realize value through an exercise which results in forfeiture of the option’s future time value.
Further, employee stock options are not hedgeable.
These
features make the employee stock options worth less than exchange traded options, but the proposed statement does not provide for a
discount, resulting in an inherent overstatement of compensation expense.
The proposed statement would also result in the overstatement of compensation expenses
related to employee stock options because the calculation methodologies do not adjust for the nature of employee stock awards.
Stock option awards are inherently worth less to an employee
than an external investors’ exchange traded options for the following reasons:
1. An employee’s risk tolerance cannot wholly align with the terms of the option award.
2. An employee’s liquidity needs vary over the life of an option award.
3. A typical employee does not have sufficient information or sophistication to properly value of the award, and thus there is a valuation
discount.
4. An employee’s diversification needs are not compatible with option awards.
For the aforementioned reasons, employees will not place the same value on their options as an external investor does on exchange traded
options. The proposed standard does not recognize this key difference, resulting in a systematic overstatement of employee stock awards.
The greatest problem with the proposed valuation method for employee stock options is
the inability to accurately determine input variables used in the model. Slight changes in the expected term of the option or the expected
volatility ofthe price of the underlying share have a dramatic effect on the value of the option yet there is no way to reliably estimate these
variables. For Micron, which has experienced historically high volatility and constantly changing exerCising patterns, utilization of two alternative
reasonable, supportable estimates of the model variables would result in a computed cost that varied by more than 100%. By the Exposure
Draft’s provisions, both of those results would meet the approximately right characterization, but would be virtually useless to the investment
community.
Micron has historically experienced dramatic changes in our operations and market. The following are examples of some of these changes:
In 1998 we acquired the operations of one of our major competitors, which more than doubled our manufacturing capacity, enabling us to
increase our market share in the DRAM industry from approximately 7% to approximately 20% in less than three years,
In 2000 we disposed of our PC operations, which had constituted more than 50% of our net revenue in fiscal year 1998.
We have pursued a number of new markets outside our core DRAM operations that could significantly change the nature of our business.
Our primary industry DRAM has cycled through severe imbalances in supply/demand relationships of our commodity product over the last
10 years leading to dramatic changes in our operating results and stock price.
The DRAM industry has also undergone a major consolidation with many firms exiting the business and a small number of companies
holding greater than 75% of market share.
The dramatic changes in our business resulting from the aforementioned and other
changes greatly diminish the likelihood that the historical volatility of the Company’s stock prices is representative of the future volatility of the
Company’s stock price. Factoring any changes into expected volatility is highly subjective at best and fraught with error. For example,
most
stability and less volatility in market pricing. Actual results over the past few years have been exactly the opposite as volatility increased.
outside analysts predicted that consolidation of the DRAM industry would lead
to greater
Accurately estimating the expected term of employee options is equally difficult.
Historical exercise behavior is dependent on a number of factors that are constantly changing such as the following:
Spikes and drops in our stock price which change employee perceptions of risk and return
ftheir stock options.
Recent success of the Company which alters employees’ personal financial position as a result ofthe Company’s compensation plans being
significantly variable.
Changes in the demographics ofthe Company’s employees which have become significantly more international and older as the Company
matures.
The average term of the Company’s employee stock options has varied substantially in
recent periods due to market conditions and changes in behavioral factors. There is no reliable method to estimate the affect of changes in
bchavioral factors on the expected term for employee options.
Under the proposed statement, a company’s ability to accurately estimate the variables
required in stock options valuation model would be severely constrained. Paragraph B17, of the proposed standard asserts that “Data and
assumptions used to estimate the fair value of equity and liability instruments granted to employees should be determined in a consistent
manner from period to period.” To avoid the appearance of being inconsistent or of manipulating earnings companies will likely avoid the
subjective and difficult adjustments to variables that are necessary to accurately reflect real changes in current conditions. The Exposure Draft
creates a very significant dilemma for an issuer.
Adjustments to how model inputs are estimated could
ereate issues with independent auditors and subject the company to increased litigation risk.
It is our position that a flawed valuation model based on inaccurate variables will not
result in a reasonable approximation of the cost of employee stock options. We strongly disagree with the Board’s contention that for employee
stock options it is better to record a cost that is “approximately right” than to not record any cost for several reasons:
I. Recording transactions based on uureliable data gives the impression that the information has much greater precision than it does.
II. Based on reasonable estimates of data inputs there is little confidence that the calculated cost of stock awards is closer to the actual value
of the award than a $0 value.
III. Unlike other cost accruals which merely allocate expenses between periods, stock
ption valuation result in estimation differences that are permanent and never reconciled.
IV. The valuation method in the proposed standard results in a systematic overstatement
f compensation expense by failing to account for certain differences between employee and exchange traded options.
Need for Field Testing
As is evidenced by the overwhelming response to the Exposure Draft from business leaders,
financial experts, investor activists, academicians and the media, there is no consensus on what constitutes appropriate treatment of employee
stock options. In order to achieve a workable consensus we believe it is imperative that FA SB implement rigorous and widespread field testing
before any new standards are adopted. To be effective any such field testing must include companies that range from large multinationals to
small domestic start-ups. Widespread field testing would provide FA SB with a forum for identifying, understanding and addressing the practical
challenges and implications of the proposed standards.
We understand that FA SB has
successfully used this type of field testing in the past and encourage you to do so again.
****
Thank you for giving us the opportunity to comment on the Exposure Draft. If you have
any questions or need any additional information from us as you deliberate your course of action, please do not hesitate to contact me at (208)
368-4621.
Very truly yours,
/s/ W. G. STOVER, JR.
W.G. Stover, Jr. Vice President of Finance and Chief Financial Officer
ce: Director@fasb.org