NCPA - National Center for Policy Analysis

Setting a Value on Stock Options

May 9, 2002

Should corporations be required to count options granted to employees as an expense in their financial reports? That's a hot topic in the post-Enron accounting universe.

After all, options certainly dilute the value of stocks, since they enlarge the claim on a corporation's earnings. The problem, however, is to place a value on the option.

Once reserved for only a handful of corporate top executives, they are now handed out as compensation to many lower level employees and are thought to have amounted to more than $100 billion as of 2000.

Some reforms concerning options are being debated. Here are some of the suggestions:

  • Much of the problem would vanish if people paid attention to diluted earnings per share rather than basic earnings per share.
  • Companies should be required to report not only options grants, but also all transactions involving their own stock.
  • Companies should be required to report within a day or two all insider trades, including option exercises -- not 25 days later, the current average.

Such moves would certainly be reasonable and simple changes, some economists contend.

Source: Hal R. Varian (University of California at Berkeley), "Economic Scene: In Accounting for Options, Knowing About Diluted Earnings Is A Powerful Tool," New York Times, May 9, 2002.

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