Rogue Missives Friday, July 18, 1997

Part 4:
A Senator Speaks Out

According to Senator Carl Levin, a Democrat from Michigan and the leading Congressional voice against this industrial policy, stock options are the only kind of pay companies can classify as an expense for tax purposes without ever showing it as an expense on the firm's books. In his view, the current accounting arrangement is merely "a tax loophole" that provides a "stealth tax benefit" that does nothing to help mom-and-pop operations, small private firms, or farms but does a great deal to help "the largest and wealthiest members of the corporate community." The tax benefits are astonishing. For fiscal year '96, Microsoft paid $758 million in taxes but saved $352 million in taxes thanks to write-offs following the exercise of stock options. Cisco Systems paid $335 million but held onto $198.5 million due to options. 3Com spent $35 million but got a tax benefit of $79.8 million. Sun Microsystems coughed up $194 million to the I.R.S. but saved $55.9 million. And so on.

A Dynamic Worth Considering

Levin has charged that American taxpayers are essentially subsidizing a form of corporate welfare that ultimately "is fueling the wage gap." Backing up his argument, Levin sites an April issue of Business Week that reported average total CEO compensation soared by 54% last year on top of a 30% increase in 1995. Meanwhile, blue collar wages rose by just 3% and white collar compensation by 3.2% in 1996. A recent study from Executive Compensation Reports, a leading publication devoted to the topic, found that in 1996, stock options accounted for 45% of total CEO pay. Largely because of the growing corporate reliance on options encouraged by the current tax structure, the average CEO compensation has risen, according to the Business Week study, to 209 times the average pay of a factory worker. In 1991, the ratio was 100 to 1. In 1980, 40 to 1. In 1996, CEOs in Japan made about 20 times what a factory worker did; in Germany, the ratio was 25 to 1.

Levin introduced legislation in 1991 designed mainly to rouse the FASB, to get the accounting board to lay down the law it had dithered over. Because that battle led to the current compromise, Levin and Senator John McCain, a Republican from Arizona, recently introduced the "Ending Double Standards for Stock Options Act." This bill would require companies to treat options as an expense on their books -- and thus report lower earnings -- in order to claim them as an expense for tax purposes. Companies that decided not to do so would miss out on the tax break. The only exception would be companies, like INTEL <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: INTC)") else Response.Write("(Nasdaq: INTC)") end if %>, which now offer a broad-based option plan that includes all of a company's employees. The plan also needs to gives at least 50% of the options to non-management employees and to avoid giving one employee more than 20% of stock options in any one year. Aside from raising about $933 million in taxes over ten years, the bill would encourage companies either to share stock options with the average worker or face shareholders with the real numbers showing how much executive stock options actually eat into results.

The Levin-McCain bill doesn't stand a chance. Still, it speaks to an enduring ambivalence Americans feel at the sight of enormous executive compensation packages, even the tens of millions of dollars that go to Coca-Cola's Roberto Goizueta or Intel's Andy Grove, two CEO's who, arguably, deserve whatever they get. If the current tax structure amounts to a form of industrial policy, it's certainly reasonable to argue that it could be changed to refocus that policy and to correct abuses. Even so, the rightful people to correct those abuses are probably the shareowners themselves. The FASB's new disclosure rule on expensing options should help raise investor awareness of the issue. So too will another recent FASB statement, number 128. This rule requires companies to report both "basic earnings" (income available to common stockholders divided by the weighted-average number of shares outstanding during a period) and "diluted earnings" (which reflects the possible dilution resulting from the exercise of options, warrants, or other contracts to issue common stock). Though reduced merely to financial footnotes, these new disclosures are there for the interested.

Part 5: A Dynamic Worth Considering

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