The Employee Ownership Update
March 7, 1997
FASB Issues New Rules Affecting Stock OptionsThe Financial Accounting Standards Board (FASB) announced this month (March 1997) that it would change accounting standards for the way companies calculate per-share net earnings. The new rules are effective December 15, 1997. The rules will have a particular impact on companies with stock options. Under current rules, companies report "primary" earnings per share based on the fully diluted outstanding shares. In other words, options, warrants, and other convertible securities are counted as outstanding shares. Under the new procedures, companies will instead report "basic" earnings per share, excluding these securities. By reducing the number of shares in the denominator of the earnings per share calculation, the resulting ratio will be larger, all other things being equal.
The FASB rules also change fully diluted earnings reporting procedures. Under current rules, these include the fully diluted effects of options, warrants, and other convertible securities. To determine the value of stock options, companies currently calculate the value of options as of their price on the last day of the quarter being reported. Under the new rules, the average price during the quarter will be used. This would mean a higher price/earnings ratio in a rising market.
Travelers Group Sets Up Unique Stock Option/401(k) PlanThe Travelers Group, a financial services company that includes Travelers/Aetna Insurance, Smith Barney, Commercial Credit, and other businesses, will make annual contributions of stock options equal to 10% of pay to all employees participating in its 401(k) plan. Pay over $40,000 per year will not be included, however. The options will not be granted as a match to employee deferrals into the 401(k) plan, but rather will go to everyone eligible to participate in the plan, even if they defer nothing. The options vest immediately, but can only be exercised 20% per year. They expire after 10 years. Unexpired options cannot be exercised by employees who leave the company voluntarily. When options are exercised, the employee will receive a number of shares equal to the difference between the grant price of the option and the exercise price. These shares can be sold within the 401(k) plan to be invested in something else if the recipient chooses.
The plan had to receive special approval from the Department of Labor because options had not been considered an eligible investment for 401(k) plans. By putting the options in the plan, employees can avoid having to pay tax immediately on exercise. The company can take a tax deduction for the "spread" (i.e., the difference between the grant price of the option and the exercise price) when the options are exercised.