No. of Recommendations: 20
Equity compensation is often abused, which is bad for shareholders. The post-dating, re-dating, and other nonsense that goes on with options is especially indefensible. But when done correctly, equity compensation is a useful and important tool to align interests and reward productive behavior, which is good for shareholders. The devil is in the details.
I suspect you'll explain why I'm wrong, and that's OK, too, for like all good Shrewders, I am here to learn.
I don't think you're wrong, I just think personally that it's more abused and much more costly for shareholders in the long run than you might. The accounting is better than it once was, but still far from realistic and still contains too many perceived "savings" that are actually costs. It's largely a racket to hide true costs from investors and tax departments.
The accounting is complicated, and I'm sure I've got it wrong, but for example I think a vesting stock grant is valued at the cost of the shares the day the program for a given employee was enacted, and that expense (always at that same original stock price!) is spread over the N years of vesting. Cut short if the person leaves. So if after five years the stock price has doubled, the booked cost of giving the person stock in year five is half its market value at the time.
I think a better way to do it would be to take a page from the semi-fiction of US bond issuance: the government isn't allowed to buy new bonds from itself, they have to be sold into the market then bought on the open market. So each time options are issued, I'd like to see firms instead be required to have previously sold publicly listed warrants with the same expiry and terms on the open market. If they want to give some of those to an employee, they should have to buy them on the open market at the going rate to give to the person. Each time stock lands in the hand of an employee (vests), the firm should have to buy that stock on the open market that day and hand it over. The cost of those open market purchases would of course be a current period expense at current cash cost, booked under employee compensation. Plus in both cases they'd have to pay all usual payroll taxes on that dollar amount, since it's just pay--giving any tax advantage to stock and option compensation is a bad idea.
Under those terms, the value that the employee receives, and the true cost to the company, and the bookkeeping cost to the company would all agree both in time period and amount. They might all be wrong because of transient price irrationality, but they would at least agree with the market value at the time--every member of the public would be able to lay out a dollar amount equal to the booked compensation cost and get the same value in return in the same time frame. As they would all be full expenses the moment that it arrives (free and clear) in the employee's hands, the reality of the expense would be entirely visible to all parties, including the compensation plan of the boss.
It would probably still be a lot of pointless long run dilution, but at least it wouldn't be done for reasons of hiding costs, and it wouldn't be incentivized.
Jim
