Mr. President, I rise to introduce the Stock Option Accounting Act. This bill has been a long time in the making. It is a strong bipartisan bill that addresses the important role stock options play…
Mr. President, I rise to introduce the Stock Option Accounting Act. This bill has been a long time in the making. It is a strong bipartisan bill that addresses the important role stock options play in our economy.
As an Accountant, and as a member of the Senate who was a small businessman for many years, I tend to believe most of the issues we address in Congress should be examined with an eye toward preserving the strength and integrity of our small business sector, and ensuring that the regulations that govern it are fair and preserve and promote, rather than discourage, innovation and competition.
I think that's something we can all agree on, so I know I won't have to go into too much detail about the importance of our small business sector, especially our small, high tech businesses. When it comes to small businesses, especially our high technology centers, we truly are the envy of the world. Our talented and creative engineers and inventors have paved the way for innovations in advanced technologies and computer software that other countries will always try to imitate.
Here in the United States, our Small Business Administration is well aware of the importance of that sector to our Nation's economy. Nearly 23 million strong, small businesses represent more than 99.7 percent of all employers, employ more than half of all private sector employees, generate 60 to 80 percent of net new jobs annually, create more than 50 percent of nonfarm private gross domestic product (GDP) and produce 13 to 14 times more patents per employee than large patenting firms.
Last week, I chaired a hearing in the Banking Committee's Subcommittee on Securities and Investment that featured testimony from the Financial Accounting Standards Board (FASB) and the small business community. It became quite evident during the hearing that FASB is ill equipped to conduct economic impact studies of the accounting standards that it adopts even through its one of their precepts. FASB may be able to conduct a cost analysis of an accounting standard proposal determining the costs of computers and additional manpower necessary to implement a new statement. But, it does not have the expertise to look at the comprehensive impact a new standard may have on the economy.
In addition, as the hearing progressed, it was evident that FASB is not listening to small businesses, and not taking their concerns seriously about a standard that FASB Board members stated was ``set in concrete'' prior to an official comment period on any draft proposal.
At the hearing, small business witnesses testified about how they are worried that the expensing of stock options would make this form of employee compensation prohibitive. They said it would make it very difficult if not impossible to attract and retain talented employees. It would also have a detrimental effect on the entrepreneurial nature and spirit of our country. In all of my years listening on this issue, not one small business owner has spoken in favor of expensing stock options.
After the hearing, I was more convinced than ever that legislation like this bill was needed to address the issue of the expensing of stock options.
A key element of FASB's current structure is its independence and I want to make it clear that I support that principle. FASB's independence, like freedom, must be earned--and it's independence does not provide a shield that absolves FASB of accountability and due process.
When it comes to the issue of stock options, a case can be made that FASB took up the project with a pre-ordained result in mind. It's no surprise, therefore, that the process that was established to pursue the matter seems to reflect a project that was begun with the end in mind. There is enough evidence there to at least make one wonder.
First, FASB doesn't seem to have given much consideration to the more than 200 public comment letters they received. The public comments made by FASB Board Members seem to also reflect a skewed process, as does the lack of response to the many high tech companies that have visited with FASB in the past several months. In addition, FASB has refused to conduct real road tests to actual valuation methods.
According to the FASB website ``Facts about FASB 2003-2004,'' the Board follows certain precepts in the conduct of its activities. They are: 1. To be objective in its decision making and to ensure, insofar as possible, the neutrality of information resulting from its standards. To be neutral, information must report economic activity as faithfully as possible without coloring the image it communicates for the purpose of influencing behavior in any particular direction. 2. To weight carefully the views of its constituents in developing concepts and standards. However, the ultimate determinant of concepts and standards must be the Board's judgment, based on research, public input and careful deliberation about the usefulness of the resulting information. 3. To promulgate standards only when the expected benefits exceed the perceived costs. While reliable, quantitative cost-benefit calculations are seldom possible, the Board strives to determine that a proposed standard will meet a significant need and that the costs it imposes, compared with possible alternatives, are justified in relation to the overall benefits. 4. To bring about needed changes in ways that minimize disruption to the continuity of reporting practice. Reasonable effective dates and transition provisions are established when new standards are introduced. The Board considers it desirable that change be evolutionary to the extent that it can be accommodated by the need for relevance, reliability, comparability and consistency. 5. To review the effects of past decisions and interpret, amend or replace standards in timely fashion when such action is indicated.
Precept number 3 greatly interests me. I am very concerned that FASB has repeatedly refused to consider the economic consequences of its decisions. The mandatory expending of all employee stock options has serious economic, labor, trade and competitiveness implications. These issues fall squarely within the jurisdiction and oversight of Congress. It's not hard to imagine what would be said of Congress if we failed to take note of the economic implications of the actions we take on the floor.
Simply put, at the end of the day, if FASB is going to earn its independence, it will have to adhere to a process that is objective, fair, open and balanced. So far, FASB seems to be more concerned about getting the job done--than in getting it right.
That is why I am offering legislation that will expense the stock options given to the top five executives of a company, exempt small businesses and start up companies, and set conditions for the expensing of broad-based options for the remaining employees. I treat the three groups differently in this matter because a very real and strong accounting distinction exists between the two types of workers.
First of all, in a very real sense the top five executives of an organization
are different from the general employee group in the manner in which they are treated by the SEC and the manner in which their compensation is defined and distributed from an accounting perspective.
The top five executives, for instance, are treated differently when it comes to their compensation and a wide range of other matters. Proxy rules, for instance, require significant additional disclosures from the top five executives than they do of any other group.
Second, from an accounting perspective, there is a clear distinction between executives and the broad employee group. In their recent book, In the Company of Owners, Professor Joseph Blasi and Douglas Kruse concluded, based on extensive research, that options granted to all but the top executives in a company are not labor income, but a form of capital income.
To quote from their book, ``They represent risk sharing profits that workers receive on top of their normal market wages and benefits. As such, it makes little sense to deduct the value of those options from profits.''
In addition, Blasi and Kruse found that, ``options turn employees into economic partners in the enterprise. As such, they stand to share in the stock appreciation that they help to bring about. . . . Options provide an additional dimension to their employment relationship, allowing workers to participate in both the risks and the rewards of property ownership. . . . There's substantial economic evidence that options bring workers capital rather than labor income. . . . The earnings workers get from options comes on top of their regular market wage.''
In contrast, options for top executives function more as labor income, particularly in companies without broad based option plans. These top executives bargain for their entire ``compensation'' package and, in many cases, stock options represent a large part of the total package. Their negotiations about compensation are distinctly different than other employees.
That brings me to our bill and its purpose--or, to continue with my line of reasoning--If these two groups should be compensated differently for their efforts when it comes to stock options, how should it be done?
Our legislation would mandate a valuation method of the options given to the top five executives that does not require companies to predict their future stock price volatility. One of the members of the Option Valuation Group, Fred Cook, appointed by the FASB strongly recommended this method--one where stock price volatility is set at zero so that companies don't have to use a crystal ball and try to predict their future stock price.
Another key principle in our legislation is the requirement that FASB develop a method of ``truing up''--or correcting errors--that are made when stock option estimates are made at grant date. There are several other areas where estimates are made in financial statements, and then corrected over time as the precise facts are learned. Today, no such corrections are made in the stock options area--a fundamental flaw in the system.
To address these issues, the bill has three major components. First, the bill would target executive compensation. A company would be required to expense immediately options of the top five highly compensated individuals at a company. The Securities and Exchange Commission already requires this information in annual statements and proxy statements. In addition, it would provide investors with a clearer understanding of the stock options of top company officials. This also would work in conjunction with the self-regulatory organization's rules, approved last week by the Securities and Exchange Commission, to require shareholder approval of stock option plans.
Second, small business would be exempt from expensing stock options. The exemption for small businesses would follow the current SEC rules for defining small businesses. The bill would allow small companies a 3-year grace period after an initial public offering prior to a company being required to expense stock options. This would allow a sufficient period of time to work out any initial volatility after the initial public offering.
Finally, the bill would not permit the Securities and Exchange Commission to recognize a stock option expensing standard unless two things happen. First, companies must be able to recognize the true expense of stock options on their financial statements. Currently, FASB wants companies to expense stock options upon the grant date of an option. Unfortunately, the current valuation models for stock options, Black-Scholes, binomial, Crystal Ball, and others, are horrible indicators of the true cost to a company stock options.
The bill would require that a company be able to ``true-up'' its financial statements when a stock option is exercised, lapses or is forfeited. If the cost goes up then the company must record the increase when an option is exercised. Likewise, if an option lapses or is forfeited then a company should be able to wipe those previously taken expenses off its balanced sheet. This is only fair.
The second item prior to an accounting standard to be recognized is the completion of an economic analysis study by the Secretary of Commerce and the Secretary of Labor. This study would look at how the use of stock options may stimulate economic growth in our nation's economy. In addition, the study would relate how stock options expensing could effect the competiveness of U.S. companies in international markets.
I strongly believe that this bill is essential to our economic strength. It is clear that FASB is not listening to small business and therefore is not listening to the future of our country. FASB is therefore ill equipped to make the economic analysis decisions to determine the true effect of stock option expensing on our economy.
In addition, the bill also targets the invasion's need for greater information on executive compensation. I ask my colleagues to take a serious look at this bill and to support its passage.
I ask unanimous consent that a summary of the bill be printed in the Record.
Sen. Elizabeth Dole (R-NC)
