NORWALK, Conn. -- The Financial Accounting Standards Board yesterday backed off requiring companies that grant stock options to their employees to deduct the value of those options from earnings.
The FASB yielded to political pressure from opponents who argued that the rule was bad accounting and bad public policy, board members acknowledged.
"We have accounting purity and we have practical reality," said Dennis Beresford, the FASB chairman, who called the FASB action a "limited defeat." Mr. Beresford said that almost complete lack of support from FASB's constituents helped doom the project, thus making the board yield to practical considerations.
As a result of the board's action, companies will be "encouraged" to deduct the value of options from earnings but not required to do so. The board said companies would be required to disclose some of the details of their stock option plans in the footnotes of the financial statements.
"It says that the FASB took a dive because of political pressure," said Graef Crystal, an expert on executive compensation and a professor at the University of California, Berkeley. "They're saying the right thing to do is to charge earnings and we hope you'll do the right thing, but it's OK if you don't."
The FASB had proposed charging company earnings for stock option grants because it believes that companies granted options as one way to pay their employees. Other employee compensation requires a charge to earnings as a cost of doing business, so the FASB reasoned that stock option grants should be accounted for the same way. Under current accounting rules, stock option grants are measured at zero.
But the FASB got bogged down over how to measure the value of options. And it was stunned by the sheer volume of opposition.
"We're saying we can determine the number and put it in the footnotes and not recognize it, for political reasons," said James Leisenring, FASB's vice chairman. "I can accept that."
When accountants use the term "recognize," they mean taking a number and putting it on the face of financial statements, not in the footnotes.
The action is a victory for the American Electronics Association and other lobbyists, whose efforts ranged from writing thousands of negative comment letters to the FASB to organizing rallies attended by workers in California's Silicon Valley.
The AEA's allies eventually grew to include several lawmakers. Among them were Sen. Joseph I. Lieberman (D-Conn.), who introduced legislation that would have directed the Securities and Exchange Commission to ignore any FASB rule charging stock option values to earnings, and Sen. Phil Gramm (R-Texas), who's expected to be named chairman of a new securities subcommittee under the aegis of the Banking Committee, to be chaired by Sen. Alphonse D'Amato (R-N.Y.) after the Republicans take over control of the Senate in January.
"I am thrilled FASB has finally acknowledged that footnote disclosure of stock options is the way to go," Mr. Lieberman said. "FASB's original plan would have devastated the growth sector of our economy."
"I think the best thing to say is no comment with an explanation point," said Peter Knutson, an associate professor of accounting at the Wharton School at the University of Pennsylvania and the chairman of financial accounting policy at the Association of Investment Management and Research, an analysts' trade group. "This stopped being an accounting issue and became a political issue, and it was settled by politicians, not accountants. I think that's a rotten way to set accounting standards."
Mr. Crystal said today's capitulation cast doubt on the future of the FASB's independent role, in part because of its admission that it couldn't agree on how to measure the cost of options.
"There are tremendous estimates requiring assumptions far more complicated than valuing options," he said. "Look at medical costs or retiree medical expenses, and try to figure out the cost of procedures in 2030 that haven't even been invented."
But the real issue was executive pay, Mr. Crystal said.
"This is not an exercise in rocket science. You will find FASB has less problem with derivatives than stock options," Mr. Crystal said. "The real problem is because options are tied up with executive compensation. If something affects the income statement but not the executives' pay, then that's a matter of far less concern."