Senators' stock options move could cost MS billions

IT giants could have to pay some tax, shock horror

Four US senators are proposing legislation that would stop companies using stock options to window-dress their earnings statements. The proposed Ending Double Standards for Stock Options Act would require companies to treat employee stock options as an expense for book-keeping purposes if they want to claim them as an expense for tax purposes. The current situation in the US allows companies to effectively hide the cost of stock options (which in essence are a part, in cases such as Microsoft a major part, of the compensation package) while substantially reducing their own tax liability.

The senators have tried this one before, in 1997, but according to a statement issued yesterday by Senator John McCain "the special interests with a vested stake in the status quo prevented this legislation from seeing the light of day." But post-Enron they're likely to have a better shot at it.

"According to one recent report," says McCain, "almost half of the earnings of the typical chief executive officer of a top company reflects stock options. Why shouldn't the value of this compensation package be included in calculating a company's earnings? How can stockowners evaluate the true value of employee compensation if the value is just buried in a footnote somewhere in the annual report?"

The system is widely used by companies as a financial engineering weapon, with Microsoft being one of the prime exponents. As we noted over a year ago, in fiscal 2000 Microsoft claimed $5.5 billion as a tax benefit against stock options, and if it had paid compensation as wages, keeping staffing at the same level would have cost it an extra $16 billion, thus resulting in the company chalking up a $7 billion loss.

Long-time critic of Microsoft financial practices Bill Parish describes this as getting employees to prepay their own wages (you get paid less for taking bits of paper you have to hold onto for a couple of years until the options mature) and points out that the effective misrepresentation of company performance causes inflation of share price. Given that this results in Microsoft stock having a strong presence in pension portfolios a collapse of the pyramid (which he predicts imminently) would result in major financial damage to American savers. Parish covers this and much else, in much, much detail, here (section 4 in particular).

Whether or not Armageddon beckons if the tax regime isn't changed, the adoption of the Stock Options Act would certainly, one way or the other, lop billions off the stated bottom lines of Microsoft and similarly engineered operations. McCain points out that Enron used options to reduce its tax payments, although he says it is not as yet clear whether the company used the current disclosure rules to hide its financial problems.

Bill Parish tells us that Enron CEO Ken Lay boasted about using Microsoft's "playbook," and while we haven't been able to nail down a quote in quite those terms, we do find the BBC reporting: "'We like to think of ourselves as the Microsoft of the energy world,' Mr Lay has been quoted as boasting." So was Enron ahead of the curve, or did it just, as Parish says, not understand how the financial engineering was structured? ®