ACCOUNTING FOR STOCK OPTIONS

For many years, stock options provided companies with a key tool used to reward employees and executives. Beginning in the 1980s, stock options became an increasingly popular way for companies to tie corporate performance to compensation for chief executives and key managers. This trend reached its peak in the 1990s, but with scandals at Enron and other companies, stock options have come under increased scrutiny. Over the past half century, the professional manager has emerged as the chief executive in many large firms. Unlike the firm’s original founders, these executives often own only a very small percentage of the company’s outstanding stock. This can create the potential for a conflict of interest between the executives maximizing their own individual benefit and the outside owners wanting the company’s value maximized. The use of stock options is usually reserved for decision makers in the company, with lower-level employees offered stock purchase programs (if any stock benefit). This research examines stock options, recent events at the FASB that have changed how companies account for their options, and the consequences of those changes to the business and investment community.

Stock options are essentially the right to purchase stock at some specified date in the future at an agreed-upon price. This price is not related to the price the stock is being traded at either at the time of granting or the time of exercise. For example, a stock option might be given to a CEO that allows the CEO to purchase 1,000 shares at $15 per share at any time during the next five years. If the market price is above $15, the CEO makes a profit by purchasing the 1,000 shares, and then selling them; if the market price is below $15, the CEO does not. Since the CEO is primarily responsible for the direction of the company over the five-year period, the incentive is for the CEO to maximize the company’s performance in order to increase th…

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