Will Options Expensing Drive Down Stock Prices? Business Professors Say "No"

A common assumption in the stock options debate is that expensing will drive down the prices of companies that provide options in a more than nominal way, and will be especially hard on companies with substantial options grants. But many people have argued that information about options is already available and, besides, investors care mostly about cash flow and other hard economic measures, not accounting conventions. To probe this issue further, we conducted an e-mail survey of business school finance professors at 30 leading business schools. We received 37 responses. The professors were asked two questions. The questions and the introductory material appear below:

As you know, there have been recent proposals to require companies to expense the present value of option grants to employees as a compensation cost on their income statements. Current rules require companies to show this expense in their footnotes or on their income statements (over 95% choose footnotes). This two-question survey is intended to find out what, if any, impact on stock prices economists expect this change to have.

1. Which of these statements comes closest to representing your views about the short-term impact on stock prices of requiring companies to expense the present value of option grants to employees as a compensation cost on their income statements?

a) It will have no significant impact on stock prices because the market already has incorporated this information.
b) It will have a small impact on stock prices.
c) It will have a substantial impact on stock prices.
d) It will have a small impact on stock prices of companies with options expenses larger than industry norms.
e) It will have a large impact on stock prices of companies with options expenses larger than industry norms.

2. Do you think companies should expense options?
a) Yes
b) Yes, but current accounting proposals for expensing are unrealistic.
c) No
d) Other

On question 1, 14 people answered a, 7 answered b, 2 answered c, 10 answered d, and 4 answered e. In other words, only six of the respondents expected that expensing will have a substantial impact on stock prices for any of the companies with options. The remaining 31 respondents expected either no impact or a small impact. The respondents did, however, think companies should expense options. Twenty-eight respondents chose a, five chose b, three chose c, and one chose d.

So what can we make of this limited research? These experts seem to think that expensing might turn out to be the "Y2K" problem of stock options, much feared but of little consequence. Of course, it is impossible to predict how the market will respond with any precision, but, at this point, it seems that it would be safer to bet that the impact will be nominal. If this is the case, companies should certainly not make wholesale changes in their plans just to respond to a non-existent problem. Instead, they should design their equity compensation so that it serves their real economic and human resource needs, not their accounting convention needs.