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Silicon Valley view
Quit whining, tech industry, and help formulate new rules

By Dan Gillmor
Knight Ridder Newspapers

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Barring a last-second reprieve from an increasingly reluctant Congress, companies are going to have to follow some new rules from the Financial Accounting Standards Board (FASB) — rules that will require them to subtract the cost of options from reported earnings.

Yes, there are some flaws in the board's logic. But instead of fighting an all-or-nothing battle, the tech industry would be smarter to help FASB tweak the new rules.

The FASB move is aimed, ultimately, at making corporate accounting more honest. But the likely impact goes way past that.

Shareholders' interests are clearly at stake. Public trust in corporate governance is also on the table. And so is the future of innovation in America, if you listen to the valley's increasingly shrill leaders.

The last of those is the most serious issue. As some tech executives see it, innovators will soon flee in droves to China and other places that don't follow these rules.

America faces plenty of challenges. But real innovators have replaced the fast-buck crowd that flocked to the valley in the late 1990s.

Real innovators want to make money, of course, but they want to create real value in any number of ways — and options are only part of that equation.

Besides, the best innovation happens in startups, which don't report their finances publicly. At the time of a buyout or IPO, investors or purchasers can surely make sense of the balance sheets however FASB writes the rules.

Not necessarily bad

Contrary to some reactionary thinking that emerged after the stock bubble deflated, options are not a bad thing. Done right, they can truly spur hard work and loyalty. But when they become lottery tickets, they spur less useful behavior.
 
Executives, of course, found ways to make their own lottery tickets into sure things. They and their accountants, lawyers and pet board members helped create the justified public fury over corporate abuses.

The widespread skewing of options to the people at the top of some companies turned the notion of "aligning the interests of shareholders and employees" into an outright lie. Again and again in the bubble years, management's main goal seemed to be pumping up share prices, by any means, just long enough to cash out. Anything that dampens such behavior has merit.

The critics make a better point when they note that options are not a direct cash expense in the normal sense. Yet they do have value. A barter deal isn't cash, either, but it gets reflected on the books.

The tech industry invites ridicule when it complains that expensing options would create misleading financial statements. Yet today's financial reports already involve creative fiction in many cases. (Defenders of options insist, unconvincingly, that today's statements are entirely clear.)

To listen to the industry, investors are smart enough to figure out the real deal under the current misleading accounting system. Yet the very same investors will suddenly become too stupid to grasp a different accounting system that also has some fuzzy features.

The next argument the tech industry makes is that companies can't accurately estimate the value of the options. Sure, it's tricky, and it may even invite new kinds of financial manipulation. But it's not impossible, and chicanery can be punished.

The executives who get giant options grants as part of their lucrative compensation have surely calculated their value, or at least someone must have run the numbers for them (and the company) in contract negotiations.

Forming alternatives

If the industry wants to make the proverbial lemonade from what it considers a lemon, it should help FASB come up with valuation methods that give investors a more realistic understanding of options' impact. The accounting board effectively invited such assistance in its proposal.

But if the industry wants to keep insisting it's Silicon Valley's way or the highway, it'll end up alienating even its friends. Using the options debate to threaten even more offshoring of jobs is not a smart tactic, by the way.

Whining time is over. Investors and financial analysts will learn, if they didn't know already, to go beyond earnings-per-share numbers to see how companies are really doing relative to their industry peers.

Let's get back to what the valley really does best: innovating, and building lasting value.

Dan Gillmor is a columnist for San Jose Mercury News

Copyright © 2004 The Seattle Times Company