No Accounting for Congress
I am incensed at H.R. 3574, the bill the house passed yesterday trying to tell companies how to account for stock options. There is a reason that we have an entity independent of Congress make accounting rules. Accounting is subtle and the companies who have influence in Congress often want to push the rules in directions which are not in the best interest of the markets overall. This is similar to the reason that we make the Federal Reserve separate from branches of government. Can you imagine the house passing a bill saying that Alan Greenspan has to cut interest rates? Suddenly I can. (Incidently, when I was in Argentina last year, I was surprised to hear some Argentine economists suggest that the lack of independence of their central bank is the key to their economic difficulties. Whenever a politician needs to be reelected he can pressure the bank to release more money. To him, the Fed was much more important than things like an independent judiciary.)
And if you have any question about the House’s ignorance on the matter, one only needs to look at the rhetoric both sides are using on the floor. Whether a company expenses stock options has nothing to do with whether we think stock options are a good or bad thing. It merely reflects the fact that options represent an obligation that will cost the company money. Paying for salaries and health care benefits are surely a ‘good thing’, but that doesn’t mean we let companies act as though these things come for free. Accounting isn’t about whether a company is doing good or bad things. It is about truth. Which is why there is no controversy among accountants about the merits of the FASB’s rule.
But members of Congress think that accounting should not be about truth, it should be about helping the economy. According to Representative Anna Eshoo the FASB is proud of ignoring the economic effects of their rules, but “Congress does have a responsibility when it comes to the economy.” Yes, the FASB is concerned with telling the truth, because we assume that in accounting standards truth-telling is the best thing for the economy. But saying that they need to decide whether accounting standards are good for the economy is akin to saying a libel judge can decide that the public and false demeaning statements about someone are acceptable if they had the positive effect of boosting newspaper sales. This suggestion is an interesting reversal of earlier opponents to option expensing, who said that we shouldn’t expense precisely because it will have no economic effect, because savvy investors will be able to sort out the long-term costs whether or not they are on the income statement. At least they were wrong for the right reasons.
Representative Zoe Lofgren goes on to make one of the most bizarre comments on the subject matter when she says that it would: “It would drive a stake through [the tech sectorÂ’s] heart, so this should be a concern of the U.S. Congress, and 312 votes indicate it is. We should know what we’re doing here before we allow the green-eyeshade guys to disrupt the economy.” Huh? Is this a disparaging remark about accountants, that they live in the emerald city and donÂ’t see the effect they are having on everyone else?
The argument that option expensing will hurt the economy comes up again and again. Senator Barbara Boxer says asks: “Why on earth would we make ourselves, on purpose, uncompetitive, unable to draw the best and the brightest people and hurt ourselves in the global marketplace? That is just like punching yourself in the face. Yeah, FASB’s (Federal Accounting Standards Board) unelected. That’s just the point. Why would we allow an unelected body to hurt the U.S. economy?” Beyond the fact that she slanders and organization with far more credibility than the elected Senate, there is this unspoken premise that this rule will somehow hurt the economy. (Pete Sessions continues the FASB-bashing when he calls the Connecticut-based FASB ‘inside-the-Beltway accounting techniciansÂ’.)
I havenÂ’t seen anyone justify this economic argument, but it is presumably based on one of two arguments. The first is that expensing stock options will significantly reduce the income of some tech firms (this is true), and that this will depress the stock market. This assumes that investors who value a stock donÂ’t consider the long-term costs of stock options today, and having them do so would be a bad thing. Neither of these is correct. If investors ignored the cost of options it might make the stock market go up for a while, but they would eventually realize their mistake and adjust for it, and it would cause more bubble-like behavior in the market. Over the long term, markets measure how much money companies actually make, not how much accountant say they are making. Regardless, there is plenty of evidence that markets immediately adjust for stock option expensing. IBM, Microsoft, GE and plenty of other companies have chosen to expense stock options, and none of them have seen a significant stock decline. (Interestingly, this fact used to be frequently sited by the opponents of expensing, as proof of why expensing doesnÂ’t matter. This was, at least, a better reason for their wrong opinion.)
The other side of the economic argument is that companies will use options less, which are a vital part of our entrepreneurial sector. This is also a curious assertion. The rule will not affect private companies (who do not need to file statements consistent with the FASBÂ’s principles), so what we are really talking about is bigger technology companies. I am suspicious of the assertion that stock options are a key part of our entrepreneurial economy, which thrived for many years without equity-based compensation. But even if options are essential, expensing in no way penalizes companies for using them. Yes, it causes their income to decline in the short-term, but so do any number of other investments. Companies continue to make these investments because they are important, and explain to investors why they are doing so. Giving out a stock option is like building a factory, it costs you something now but it becomes worth it down the line. Expensing is only a penalty to companies that cannot justify the costs of the options they are giving out.
In addition the billÂ’s supporters continue to recite the often-repeated argument that we donÂ’t know enough about the behavior of stock options to accurately account for them. Which in one sense is true, like many accounting items, our measure of the value of options is an approximation. But whatever inexact approximation the FASB comes up with, it is guaranteed to be more exact than the current approximation that the cost of stock options is nothing.
But suppose that you accept the premises that options are a bad thing, expensing them will hurt the economy, and we donÂ’t really know how to do so in the first place. IsnÂ’t it odd that in an attempt at compromise this bill actually says that companies do have to expense the options they give their five highest paid employees. Why would we want companies to do this bad an inaccurate thing on a small scale? WouldnÂ’t that promote all kinds of abuse in deciding who the top 5 are? That clause seems to be nothing more than a lure to draw an anti-business contingent on board, by demonstrating that Congress is still hurting rich people in some nebulous way.
One of the curious suggestions of a number of supporters of the bill is that the FASB has recently jumped on an option-expensing bandwagon in a trendy post-Enron attempt to reform corporate accounting. It is true that the FASB has made some appropriate adjustments after Enron, but it supported option expensing years ago when Joe Lieberman and other members of Congress intimidated them into no enacting it, with threats of the same kind of encroachment on their autonomy we are seeing today.
I cannot even support the opponents of the bill, because their understanding is just as ill-founded as the supporters. As Representative Pete Stark sarcastically suggests: “Let’s give more money to the millionaires. We must help those people. That’s what this bill today is doing.” However, a level-headed Barney Frank gets it right, as does Pete Gillmor when he says that “real issue is whether we want to politicize accounting standards. Stock options should be honestly stated as expenses.”
Fortunately, there is evidence that cooler heads will prevail. Neither presidential candidate supports the bill (although it doesnÂ’t seem like a topic for which Bush would dust off his veto power). Senator Richard Shelby chairs the Senate banking committee, and is committed to the FASBÂ’s independence. (I find it odd to be supporting holding up a bill in conference committee.) I donÂ’t know much about Shelby, but this impresses me. In addition, Senators Fitzgerald, McCain, Levin and Durbin have introduced a bill to protect the FASB from meddling. I will write Senators Dole and Edwards and tell them about how all of the accounting I have learned at Carolina indicates to me that supporting the bill is a good idea.
As upset as I am at the poor judgment of politicians, the fact is that they are being lied to and manipulated by executives at big companies, who would prefer to direct their attention and their shareholdersÂ’ money to undermining financial credibility rather than delivering better products. They should not stop giving stock-based compensation, but they should be willing to admit that it has a cost and be accountable to their shareholders for that cost. I once heard the notion of companies influencing their accounting standards compared to children choosing their own grades. The difference in this case is that the children have tried to take over the Board of Education. If they succeed, it will be an awful precedent. In fact, if we were going to mix the two, I would prefer to have the FASB regulate the accounting tricks that Congress uses to pass bloated budgets rather than having Congress tell companies how to write their books.
July 22nd, 2004 at 1:51 am
How is this different from most of what congress legislates? It seems to me that almost everything they do involves some incredibly complex field of which they have very little understanding. They passed the DMCA in, for the most part, complete ignorance of the nuances and implications digital technology and even of existing intellectual property law. Portions of the ESEA seem to reflect a real ignorance of how schools actually work. And so on….
Very few things benefit from being politicized, and very few things that pass through congress are not. Like you, its gets my feathers up when one of these bills hits close to home, but I don’t think this bill is exceptional in any other way. Stuff always works like this. As Bruce Scheneier put it (roughly), politicians are interesting in consensus, not reason.
July 22nd, 2004 at 1:46 pm
IÂ’ll grant that this issue bothers me more than most, largely because I am better informed about it. But there are three areas in which I find it particularly egregious. The first is that generally there are two sides to an issue in Congress, and to the extent that the body makes the wrong decisions it does so because it fails to weigh them correctly. For example, the DMCA gives too much weight to the rights of the owners of IP and not enough rights to the users. However, in this case one of the sides is about as logical as legislating the value of pi (which is why expensing is so non-controversial to experts). This is probably true in many other cases where I am less familiar with the subject matter. But you would think that the strongly stated opinions of Alan Greenspan and Warran Buffett might give pause to two thirds of the house. (Given that fact that after the past few years, I did not think that the House would unite to vote against corporate accountability and transparency.) Second, although Congress usually get lobbied by special interests on topics, it is generally the case of some interest spending their money supporting their own agenda, as opposed to this situation where executives spend their shareholders money to make them less accountable to those same shareholders. Third, this propensity for abuse is exactly why we turn accounting over to an apolitical body. While Congress is prone to passing legislation that violates the First Amendment, we rely on the theoretically non-political courts to keep them in check. (I like to believe that CongressÂ’s carelessness regarding the Constitution is related to the fact that they know the courts will check them.) While the independence of the Federal Accounting Standards Board is not constitutionally enshrined (and not as important as that of those bodies which are), it was set up specifically for the purpose of putting accounting rules in the control of experts not prone to political influence. And it is remarkable how quickly the House disregards the value of something not being under its control.
In some ways, this represents American democracy working just the way it is supposed to. The House is designed to be easier to influence and more responsive, and the Senate is designed to be more careful and conservative. WeÂ’ll see if this process produces the correct result.
August 5th, 2004 at 5:56 pm
“…before we allow the green-eyeshade guys to disrupt the economy”
Heh. I get this fabulous image of giant accountants in the old-fashioned green visors and suspenders rampaging through New York, blasting Wall Street with their radioactive eyebeams.