Let's Get Stock Options Under Control

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It's not a case of the fox guarding the chicken coop. President Bush should listen to Warren Buffett on fixing business woes, argues the latest Against the Grain commentary from CBSNews.com's Dick Meyer.
It sure ain't business as usual when the second richest man in the world stands as the most important reformer of big business in this land of big business.

That's just what Warren Buffett is today. And he's making President Bush and congressional Democrats look lousy by comparison. With luck, he'll shame both sides into moving smart and fast to fix some broken business laws.

On Monday, for the second time in seven days, the president gave a high-profile speech intended to buck up investor confidence, offer assurance about economy as a whole and show resolve as a corporate crime-fighter. And for the second time in seven days, the market tanked after the speech.

Also on Monday, newspapers reported that the Coca-Cola Company would start subtracting the costs of the stock options it grants to employees from its yearly earnings.

Later in the day, The Washington Post Co. announced it too would account for the value of stock options as an expense.

By dinnertime, the Senate, controlled by Democrats, declined to mandate these same accounting changes for stock options for all companies – for the third time in a week.

The leading and most credible advocate for these seemingly arcane accounting changes is Warren Buffett. Mr. Buffett happens to be a director and a major (really, really major) stockholder of Coke and the Post.

Other companies will surely follow the Buffett example, and real reforms will be firmly in place in at least a token number of companies, while Washington fiddles.

Buffett and many others believe that reining in the stock option boom is absolutely central to curbing the current crime wave. How come?

Simply put, stock options can give company executives powerful, short-term incentives to artificially boost their company's stock price by making their books look better than the businesses really are.

A stock option gives an employee (or a director) an "option" to buy company stock at a certain price in a certain time frame. If the stock is trading for more than that certain price in that certain time frame, the "option" has value - it is profit.

CEOs of the nation's largest companies receive more than half their compensation in the form of stock options. And the current string of scandals clearly shows the danger of situations where top executives can cook company books to give short-term boosts to stock prices, thus making their options more valuable. Valuable is an understatement: Croesus-like wealth is commonplace for execs at even the most mundane big companies and stock options are the path to it.

Options are the means of acquiring what investment bankers call "f--k you" money – money so big you don't care what happens to your company – or anything else – ever again. Cash in the options, get out and it really doesn't matter if the company is bankrupt, the workers are on the street and shareholders are up a creek two weeks later.

The government gives stock options favorable treatment, making them nearly irresistible for companies. Corporations can deduct options on their taxes (lowering their tax bills) but (unlike regular salaries) they don't have to report them as expenses against revenues in their financial reports (thus making the company's profits appear larger).

Microsoft, for example, said that if its 2001 financial reports had treated options as an expense, its profits would have been reported as $5.1 billion rather than $7.3 billion. That's a 30 percent difference.

Sanford Bernstein & Co., the New York analysts, estimate that if the country's 500 biggest companies had subtracted options from revenues, their annual profit growth from 1995 to 2000 would have been 6 percent instead of 9 percent.

Buffett and company don't want options banned, they just wanted them accounted for properly and fairly compared to other expenses.

Twice in the 1990's the Financial Accounting Standards Board, a private group that sets accounting rules, tried to clean up the counting for stock options. Twice it was blocked by pressure from industry and Congress. Interestingly, in 1994 the key pressure came from Senate Democrat and moralist Joseph Lieberman.

The ideology of options sounds neat. Their boosters argue that options make management interests coincide with the stockholders. They have been most famously and promiscuously used by tech companies, who still lead the lobbying against reform.

And they do it well. Thanks to the Democrats, options reform died in the Senate three times in one week, despite being championed by master-crusader John McCain.

To the degree that this market meltdown is caused by crookedness, Mr. Bush has not done his job of persuading the public that he is a vigilant and competent corporate crime cop. He has flip-flopped all over the place about what new legislation he'll support. Now he must support, indeed insist on, the tougher reforms passed by the Senate over weaker House proposals.

But earning credibility on this is made more difficult by his resume, by his record in the oil and baseball businesses – and by the new press attention to that record. He's not a natural for the get-tough-on-boardroom-crime beat. Same for Vice President Cheney, except more so.

That credibility can come only from action, from constructing a new record now that Bush is in the White House. Rhetoric is irrelevant. Spinning his business record is irrelevant.

Changing the rules for stock options is obviously no panacea. But it's important, fundamental and symbolic. President Bush should become a convert, quickly.

Taking advice from the second richest guy in the world shouldn't be that hard.

Dick Meyer, a veteran political and investigative producer for CBS News, is Editorial Director of CBSNews.com based in Washington.

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Against the Grain

By Dick Meyer