Sharing the Wealth
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PAUL SOLMAN: As you drive through Silicon Valley these days, the landscape seems a little lonely. At least 25 percent of the office space in and around San Jose is now vacant– some tens of millions of square feet. The dot.com bomb has cleared out building after building, eliminating some 100,000 jobs in the process. The signs of the times: “Painted over” or “up for grabs.” Small wonder, then, that at a recent luncheon meeting of the San Jose Super Rotary Club, they weren’t just chowing down, but bonding…
SINGING: God bless America…
PAUL SOLMAN: …In defense of life, liberty, and the pursuit of happiness.
SINGING: My home sweet home.
PAUL SOLMAN: Happiness, however, was not the theme of the rest of the afternoon.
T. J. RODGERS, CEO, Cypress Semiconductor: They’re attacking us right now. They’re attacking the fundamental wealth creation mechanism that made Silicon Valley.
PAUL SOLMAN: T.J. Rodgers is the defiant, libertarian CEO of Silicon Valley’s Cypress Semiconductor. The way he sees it, politicians in Washington are out to kill the goose that laid their golden egg with a pernicious accounting change we’ll explain in a bit: The expensing of stock options.
T. J. RODGERS: If you look at the per capita income in San Jose, it’s higher than California, it’s double the per capita income of the United States. Why is that? Well, we’re successful because the way we share the wealth is with stock options.
PAUL SOLMAN: Stock options: To their defenders, perhaps the greatest recent innovation of free market capitalism. To their detractors, like those in Washington, an unnecessary corporate device that has been widely abused. To those who favor them, options are simply granting employees the right– that is, the option– to buy stock in the future at a bargain price, usually today’s price of, say, $9.50 a share. Then, when the stock goes up, you can exercise your option by buying the stock at the low option price and immediately selling it at the new market price, thus pocketing the difference.
Options supposedly motivate workers, like these at the Foundry, a Silicon Valley complex of medical device start- ups. The simple reason is that with stock, the workers become part owners of the company, get to share in the wealth they supposedly help create. And for recruiting executives, especially at new firms, venture capitalist Bob Pavey, who’s invested here at the Foundry, says options have become a must.
BOB PAVEY, Venture Capitalist: We need to be able to attract talented executives who have built things before and know what they’re doing. And to be able to get people to give up the… the big company perks and all that other kind of stuff, they need to have a piece of the action, they need to have a share of the ownership.
MARK DEEM, Engineering Director, The Foundry: Going into to the right carotid artery.
PAUL SOLMAN: One of Bob Pavey’s top executives is Mark Deem, who’s developing a new catheter to remove blood clots from the brain. Deem himself needs to hire talent away from established competitors on a limited– some might say a bare bones– budget.
MARK DEEM: And they’ve got matching 401(k)s and a workout room and all the other big company perks. What do I have to offer? Here’s a lower salary with a huge risk that in two years the company won’t exist and you’ll have to go fight to get back into a big company. Why would they do it? I mean, why… why would anybody?
PAUL SOLMAN: “Why would anybody” at any of these firms, from the top to the bottom? Kara Liebig works for Mark Deem.
KARA LIEBIG, Business Manager, The Foundry: Come on, let’s be realistic. There’s got to be something at the end of the tunnel. So, that is the light. It’s, you know, what fuels all the innovation. It pushes people to work harder, to be more creative, because the payoff is there for everybody.
PAUL SOLMAN: But in that case, options skeptic Graef Crystal asked a group of money managers recently, “how do you explain the fact that options don’t actually seem to correlate with better company performance, at least when it comes to CEOs?”
GRAEF CRYSTAL, Former CEO Pay Consultant: You know, with all those stock options, at the very time that options reached their acme of size, what happened to the market price? Not only is there no correlation, in fact, there’s a negative correlation. If options were so great, if anything, the technology companies stock should have weathered the storm and gone up. But in fact, they’re the ones who are the hardest hit of all.
PAUL SOLMAN: And worse still, say critics, as options grew to account for some 80 percent of CEO pay in recent years, they helped fuel the great accounting frauds like Enron. That is, executives had an incentive to goose their short- run stock price and cash in their options quickly, and thus to monkey with the financial statements. Starting in 1998, when Enron’s stock began to defy gravity, CEO Ken Lay exercised options on hundreds of occasions, pocketing over $200 million in gains. His successor, Jeffrey Skilling, exercised more than $100 million worth of options, many of them just before the company tanked. But why were executives given such huge options grants to begin with? According to Graef Crystal, it’s because companies treated stock options as if they weren’t an expense, didn’t cost their companies a dime.
GRAEF CRYSTAL: There’s an ancient dictum in accounting: “Never measured, never managed.” And this is what we have with stock options, because people just… they just think they’re funny, funny money. You know, there’s no charge to earnings, so just give them out.
PAUL SOLMAN: Which leads us to the big current policy proposal that the granting of stock options should now be an official expense on the company’s books. In Silicon Valley, this idea made T.J. Rodgers even more defensive.
T.J. RODGERS: You’ve got the government running business. And if they’re allowed to get away with what they want to do, they will turn the switch off on the economic engine that runs our valley.
BRETT TRUEMAN, University of California, Berkeley: I can’t believe that there are people in Silicon Valley who still think that stock options shouldn’t be expensed.
PAUL SOLMAN: Brett Trueman, the head of accounting at Berkeley’s Business School.
BRETT TRUEMAN: There is no question that those stock options are a compensation to employees. Clearly, they like getting them. If they didn’t, I’m certainly happy to take them off their hands. And so that means that current stockholders are giving up something of value to them. So there’s no question at all they’re an expense.
PAUL SOLMAN: So why are they having such a problem with what to you seems so obvious?
BRETT TRUEMAN: Oh, it’s very clear why they’re having a problem. They do not want to tell stockholders how much they’ve been spending on options to date. That’s why they say that when options are expensed, they’re going to cut back on the options.
PAUL SOLMAN: On this point, T.J. Rodgers, in a sense, agrees. Congress is considering legislation to expense options in ways that would make them seem very expensive.
T.J. RODGERS: They are going to pass laws that, in effect, will make stock options so expensive to give out that we won’t be able to given them to our people.
PAUL SOLMAN: That is, Rodgers argues, at tech companies especially, treating options as an expense could wipe out reported profits. Consider the potential hit to computer chip-maker Intel’s bottom line.
T.J. RODGERS: Intel has estimated that their earnings would be reduced from $2.0 billion to $0.24 billion a quarter. Well, you can only imagine what would happen to Intel’s share price.
PAUL SOLMAN: And at Rodgers’ own company, chip maker Cypress, losses of about three dollars a share in 2001 would have increased to more than four dollars a share. It’s not just Silicon Valley companies that would be affected, though. In corporate America as a whole, options now account for some 15 percent of total shares of stock. But that’s one reason famed investor Warren Buffett supports expensing them: Because they’re such a thick slice of the total. And then there’s Federal Reserve Chairman Alan Greenspan, another supporter of expensing.
PAUL SOLMAN: Why does Alan Greenspan support the expensing of options?
T. J. RODGERS: Alan Greenspan has never started a company, never created a job. He’s been an academic all of his life. So, Alan Greenspan runs around in Washington giving speeches so, what would he know about the economy other than changing an interest rate that he happens to control?
PAUL SOLMAN: Now Rodgers may sound a tad, single-minded. So when he finished his rotary speech, I stepped in with a quick question.
PAUL SOLMAN: How many people here would want options to be expensed when they’re issued? I’m not voting, I’m just… ( laughter ) …showing you how to do it. One, two, three, four. How many people do not want options expensed when they’re issued?
PAUL SOLMAN: Despite Silicon Valley’s united front, however, the pressure is on to expense options, deduct them from profits. So then, the big final question: Why do public companies care so much about the expensing issue? What difference does it make if every investor already…
T. J. RODGERS: Well, I think Intel cares if their quarterly reported earnings drops from $2 billion to $0.24 billion by a factor of ten.
PAUL SOLMAN: But sophisticated investors know that it’s just a paper…
T.J. RODGERS: But sophisticated investors aren’t all of the investors, and other investors don’t understand it.
PAUL SOLMAN: At last, then, the key to the anti-expensing argument: That unsophisticated investors will be discouraged by lower reported profits.
BRETT TRUEMAN: But the reality is that the SEC and other regulatory bodies are looking to help investors who aren’t necessarily very sophisticated.
PAUL SOLMAN: To Berkeley’s Trueman, the opponents of expensing have it exactly backwards: Unsophisticated investors need a full and clear accounting.
BRETT TRUEMAN: And to do that, you need to put important information on the major financial statements, the balance sheet, and the income statement, rather than sort of hiding it in a footnote where a lot of investors, smaller investors, less sophisticated investors wouldn’t be able to ferret out the implication of that information.
PAUL SOLMAN: And why, in the end, does it matter economically?
BRETT TRUEMAN: Without giving investors that information, they might instead think this company is more valuable than it really is. And that’s bad for the economy, because what you want in the end is for companies to be correctly priced so that money in the capital markets flow to those companies that are most profitable.
PAUL SOLMAN: Of course, the folks in Silicon Valley also want the money to flow. It’s just that they’re afraid it won’t if profits suddenly seem to vanish due to an accounting change that could frighten the economically faint of heart.