Let me tell you about the nefarious scheme in place at some major American corporations until this year. Employees were allowed pick the lesser of the current stock price and the price a year before, then buy stock at a 15% discount from that lower price. The companies failed to report this clear transfer of value on their income statements, and the employees didn’t pay taxes on it. What an outrage!
Except that, um, it was totally legal. Not just legal, but encouraged by government policy. The scenario outlined above was standard practice in the Employee Stock Purchase Plans (ESPPs) employed by lots of forward-thinking companies. Still is, except that now–under the accounting standard known as FAS 123R (a 295-page pdf of which is available here)–the value of the discount has to be reported as a compensation expense, unless it’s less than 5% of the stock price.
So what’s the difference between this practice and the options backdating that has gotten so many CEOs, CFOs, and general counsels thrown out of their jobs in recent weeks? Well, for one thing, it was explicitly allowed in accounting standards and the tax code. As Corey Rosen, executive director of the National Center for Employee Ownership, put it when I tried the ESPP/backdating comparison out on him: “If it’s okay for ESPPs it must be for options? No!“
For another, ESPPs are invariably broad-based plans, while some of the companies engaged in backdating–as I pointed out in my post Tuesday–concentrated their options grants pretty heavily among top executives.
But I still think there’s a point here worth considering as we contemplate the backdating mess. A commenter to my Monday post on this topic wrote that “shareholders of any company that has participated in options back-dating should be allowed to back-date the sale of their shares at the highest price during the past year. What’s fair for execs IS fair for shareholders too.”
Well, not really. Executives and other employees of a corporation do something crucial that outside shareholders don’t: They work there. Motivating them, luring them from other companies, and keeping them from jumping ship are all important goals, and sometimes it may make sense to use backdated or repriced or otherwise juiced-up options or other stock-based compensation to achieve them.
The problem is when companies don’t fully report such grants, and don’t take seriously the costs inherent in making them. But now all options grants have to be reported almost immediately, and their estimated value subtracted from earnings. So what’s the problem?
Yes, there are still concerns about how different companies estimate that value. But the accounting disconnect at the core of so many past problems with options–that certain kinds of stock compensation had to be subtracted from earnings and others, for no logical reason, did not–has been taken care of. Let the (fully disclosed and expensed) backdating resume!
UPDATE: Corey Rosen had a very interesting comment on this post that somehow got garbled, so we’ve removed it from the comments below and posted it here. Also, my Fortune colleague Adam Lashinsky had something very different to say on this subject a couple months back.