The folly of options expensing

Holman Jenkins today writes about a bunch of guys who have gotten together to call for ending the expensing of stock options. They include Nobel Prize-winners Milton Friedman and Harry Markowitz and former Treasury secretaries Paul O'Neill and George Schultz. See Kip Hagopian, Point of View:Expensing Employee Stock Options Is Improper Accounting, Vol. 48 California Management Review, no. 4 (a publication of Berkeley's business school).

The article apparently isn't online and I haven't read it. The title obviously makes the point.

Part of Jenkins' point is that the accounting doesn't actually matter – the market isn't fooled by lack of expensing. He adds, as I discussed here, borrowing from Geoff Manne, the same goes for backdating. Says Jenkins:

In no generic sense can one say executives "inflated" their pay or "stole" from shareholders. Backdated packages were not more "lucrative" -- it's fallacious to assume that the alternative package consisted of an identical number of options at a less advantageous price. Backdating did not provide "guaranteed" or "risk free" profits. It did not "undermine the incentive purpose" of options.

Jenkins also reiterates his point from previous columns that whatever the accounting problem inherent in backdating, it was motivated by the unrealistic accounting distinction that says only in the money options had value. As for how horrendous this conduct was, Jenkins notes "a debate among legal bloggers about whether jail time is really a proportionate penalty for an apparently victimless crime." Could he be referring to me?

I think Jenkins has been a little unclear in past columns about the propriety of expensing. While he said that it was a mistake to distinguish between in the money and at the money options, I read him as possibly suggesting that expensing was appropriate for all of them. I'm happy that he's clarified, along with the Nobel laureates, what I've always believed – that it isn't. Jenkins says, "the world would have been . . . better served if FASB had ordained that no options need be expensed."

Jenkins concludes:

Belatedly, Mr. Hagopian and allies are trying to see if anyone is yet ready to examine the real merits of the accounting argument. Had those merits gotten the examination they deserved in the 1990s, whatever the verdict eventually might have been, there'd be no backdating scandal today.

Update:  Josh Wright follows up with a superb post on the whole backdating thing, again giving credit to Geoff Manne, the fount of wisdom on this subject.

Update 2: The other Manne, better known as Geoff's dad, emailed this comment:

Holman Jenkins talks about stock option backdating and points out that no harm was done. But he is ambivalent about the correct accounting. I do not really understand why Milton Friedman or anyone should get so exercised about required expensing of options. Jenkins is quite right when he says that the important thing was to have one accounting rule that everyone understood for all options, and I do not see why it would make much difference what that rule was. Perhaps the no-expensing approach that Larry favors would be the cheapest approach, but it is not necessarily the best way of noting the existence of stock options, and that should be done. However HJ did refer to a theory of why expensing is not right, and that is that the relationship involved in an option is between shareholders and employees, not the corporate entity, and, therefore, they should not be accounted for. I find this disingenuous. A relationship between anyone and all the shareholders can certainly be accounted for on the company's books, since the corporation is their economic (if not legal) alter ego for this purpose. Perhaps as to third parties this is a correct way to look at it, but I am not convinced.