Stock option expensing boondoggle

Some time ago Congress decided to create legislation that would make executive pay more equitable considering that executives were paid so much more than ordinary workers. The simple solution, limit the tax deduction to one million dollars which would incentivise shareholders to curb excessive executive pay.

What Congress failed to consider is that business is VERY CREATIVE and it found a way around the tax penalty. Pay part of the compensation via stock option grants. In effect the company would no longer pay the non cash compensation, instead the shareholders would pay it via stock dilution. Say a company worth $1 million has 1000 shares outstanding, the value of each share is $1,000. The company gives executives options on 100 shares. The net worth of the company has not changed but with 1,100 outstanding the value of the shares has dropped to $909.09. If you own one share, the stock option cost you, a shareholder, $90.91.

Under joint stock laws, shareholders and their company are separate entities. The only liability shareholders have is the loss of their shares.

Stock options created a competitive problem for companies that do not like to pay incentives and bonuses. Stock options in growth companies are very attractive. The opponents of stock options convinced the powers that be to make companies expense the stock options which is an accounting aberration because stock option cost the company nothing, it just increases the paid in capital when exercised. That is neither profit nor loss.

If stock options are expensed then they are tax deductible! Here is the fun part! Companies have found ways to lower their tax burden. Too complicated for me to explain it, read all about it here: https://itep.org/how-congress-can-stop-corporations-from-usi…

This is the story of how Congress, in its infinite wisdom of trying to make the world fair, creates HUGE MESSES, a.k.a. unintended consequences.

The Captain

16 Likes

Risks of corporate executives being found guilty of tax fraud.

The intention of the law is clear.

This is the story of how Congress, in its infinite wisdom of trying to make the world fair, creates HUGE MESSES, a.k.a. unintended consequences.

I don’t think it is that bad, is it? In a nutshell, salaries above $1 million were not expensable for tax purposes, but performance bonusses are. Stock grants are considered performance bonuses. I say “grants” instead of “options” because most companies, especially tech companies, don’t issue stock options anymore. They issue restricted stock units which vest over time. But FWIW, the TCJA eliminated the $1 million cap. So that part of it isn’t really an issue anymore.

The disconnect comes that for tax purposes the expense is logged as the value of stock on the day the grant is vested. But for accounting purposes, the expense is logged as the value of the stock on the day it was awarded. It seems like those numbers should be the same, but I don’t think it causes a particular problem unless you think corporate taxes should be higher.

The flip side of this is employees pay tax on the value on the day the grant vests, not the day it was awarded like corporations.

1 Like

I say “grants” instead of “options” because most companies, especially tech companies, don’t issue stock options anymore. They issue restricted stock units which vest over time.

Which the recipient has the option to exercise or not. Same thing with a different name to hide what?

But FWIW, the TCJA eliminated the $1 million cap. So that part of it isn’t really an issue anymore.

But the train of events is not reversible. You can’t buy Unintended Consequence Indulgences (UCI). LOL

The Captain

2 Likes

Which the recipient has the option to exercise or not. Same thing with a different name to hide what?

No takers for the question? Let’s do a bit of history…

Once upon a time companies introduced stock options as part of executive compensation and all was well while stocks were going up but once stocks went down some executives saw their option become worthless once the stock price dropped below the strike price. Since stock options were granted by management they decided to reprice the options, lowering the strike price and sometimes increasing the number of shares. This got shareholders mad as hell! They were OK with the stock options but changing the rules mid-game to give losers an advantage was truly unfair. Stock options were no longer risky like they used to be but practically guaranteed pay.

The solution was simple, lower the strike price to ZERO and instead of calling them stock options, call them “restricted stock units.” Now it was guaranteed pay, not in dollars but in the number of shares.

The Captain

1 Like