WASHINGTON — Thanks to the Enron scandal, the public is getting to know about a scheme that corporate executives have used for years, but most of us were not smart enough to understand. You can call it the have-your-cake-and-it-eat-too ploy.
It involves stock options, the rights to buy company stock some time in the future at the (presumably bargain) price at which it is selling currently. Stock options awarded to senior management by their (usually hand-picked) board of directors mushroomed from $50 billion in 1997 to $162 billion just three years later. As Business Week pointed out in its April 15 issue, boards have been "lavishing options on executives" so profligately "that they now account for a staggering 15 percent of all shares outstanding."
This is obviously a good deal for the executives. One of them, Oracle Corporation’s Lawrence Ellison, exercised options worth $706 million in one week. A nice mouthful of cake, by any standard.
But here’s how his company — and all others like it — can have its cake too. The value of the stock options granted Ellison is a cost to Oracle for tax purposes, but it doesn’t come off the bottom line when Oracle is reporting its earnings for the year.
This would seem to defy common sense — and it does. Almost a decade ago, as the options craze was getting under way, the Federal Accounting Standards Board — the watchdog group — said that when options are granted, they should be treated as an expense in company reports as well as in tax returns. The corporate CEOs and the accounting firms they hire went nuts, and the next thing you knew, the Senate in 1994 was passing a resolution (sponsored by the great moralizer himself, Sen. Joe Lieberman of Connecticut) telling the watchdog: forget it. The 88-9 vote had the effect of keeping the cost of options as a footnote in company reports — not in the earnings per share or overall performance reported to investors.
And that has had a truly wondrous effect. On average, the Federal Reserve Board estimates, the ruling has boosted the reported earnings growth of corporations by 3 percentage points from a realistic 6 percent to an inflated 9 percent. Enron, it is estimated, used that same ruling in 2000 to inflate its earnings by more than 10 percent.
Overstated earnings, of course, boost stock prices, thus benefiting the executives who have been given stock options.
But that is not the end of it. Because these stock options are deductible for tax purposes, and their cost can be carried forward for years, they also enable companies that hand out a lot of options to stiff-arm the IRS. In Enron’s case, they allowed the company to cut its tax bill by $625 million between 1996 and 2000.
Thanks to Enron, another push is under way to stop the double-dealing. But it faces tough sledding. The Coalition to Preserve and Protect Stock Options, which includes 32 influential trade associations, is flooding Congress with "talking points" claiming that "stock options are a vital tool in the battle for economic growth and job creation … (and) to attract, retain and motivate talent."
The coalition is trying to kill a bill that would not end stock options but simply specify that companies could not use them to reduce their taxes unless they also report them as an expense in their financial statements.
The bill has bipartisan sponsorship: Democratic Sens. Carl Levin of Michigan, Mark Dayton of Minnesota and Dick Durbin of Illinois; Republican Sens. John McCain of Arizona and Peter Fitzgerald of Illinois.
Fitzgerald is particularly interesting. He is from a wealthy banking family and is a staunch conservative, but Enron has made him almost a raging populist.
It has had no such effect on President Bush. Concerned as always for the deserving rich, he told The Wall Street Journal he opposes this kind of legislation; he’s for keeping the option costs buried in the footnotes and leaving the inflated earnings reports as is.
But Federal Reserve Board Chairman Alan Greenspan testified recently in support of "expensing" stock options. The only issue, he said, is whether under current rules, "is income being properly recorded? And I would submit to you that the answer is no."
And superinvestor Warren Buffett, who hands out bonuses but not stock options to his employees, for years has been asking three questions: "If options aren’t a form of compensation, what are they? If compensation isn’t an expense, what is it? And if expenses shouldn’t go into the calculation of earnings, where in the world should they go?"
Does Bush have the answers?
David Broder can be reached at The Washington Post Writers Group, 1150 15th St. NW, Washington, DC 20071-9200.
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