Costs are still costs.

A stock option is a promise to create stock in the given quantity for the given amount under the specified circumstances (vesting, etc.).

Granting stock is more obvious.

The problem is that there is no easy way to forsee or analyze when these might be exercised, and the reported number of issued shares does not normally include this. The already bad EPSs of many companies would be worse if these virtual shares were included.

Also, forget for a moment the ivory tower ultra rational and beneficient CEO. We can keep the rational part – if the CEO wants to retire in a year, it makes sense to pump up the stock – and if obfuscating the books to hide debt, expenses, and whatever else it takes, it is in his interest to do it, and the only sign (which in the real world has been visible for the past year) will be large insider sales. Leave the company before the toxic accounting becomes visible. The CEO and others will have their money and be gone.

You might say investors should be more choosy or select companies that they understand. But they can’t all individually decode the complex accounting of every investment, and until something like Enron comes along, even an Arthur Andersen endorsement conveys trust.

The problem is more the illusion of transparency, accountability, and value. Expensing stock options might not be the best way of dragging them into the light (and if they aren’t an expense, why are they deductible? – by law public companies are forced to keep two sets of books), but they ought to appear somewhere. Otherwise a company that pays via stock options will appear (but not actually be) undervalued to an otherwise identical company that pays cash.

tz,

“Granting stock is more obvious.”

There is no shortage of things that are obvious about the expensing question. The problem is that many of them seem to logically incompatible.

I’m inclined to entirely ignore the question of option expensing until the more basic question of stock expensing is squared away to MY satisfaction.

The question of tax deductibility is no mystery as there is a real expense to the shareholders as their ownership percentage is diluted. It is entirely a practical matter for the tax deduction for the shareholders to be processed through the company. It is inconceivable that every stock or option grant or exercise would produce an impact directly on the tax return of every individual shareholder.

Regards, Don

Don,

A loss of units in inventory is a real (not opportunity) cost. The physical inventory is reduced. What is the value of that loss? Beats me. Three possibilities come to mind immediately:

1) Value at the original cost of producing those units.
2) Value at the cost to produce replacement units.
3) Value at the revenue that had been expected from the sale of the lost units.

I don’t like #3 because it’s speculative. #1 seems the most well-grounded. #2 has the shortcoming that maybe the firm will decide not to replace those units, so the replacement cost is irrelevant. But I’d need to think about this for a long while before I think I could say anything truly useful.

If the company gives units from inventory as compensation to its employees, that’s not at all like a stock option. Giving units is a real cost. You can visualize the warehouse emptying, and those units were unmistakably owned by the company.

The naked issuance (as opposed to sale) of additional stock (1) dilutes the value of existing shares and (2) requires the corporation to forego dollars it otherwise would have received by selling its shares in the open market and depositing them in its capital account. There is really no other way to look at it.

I will leave it up to the accountants to decide how it should be done, but the directors and officers are (or should be) bound by their fiduciary duties to the shareholders to account for this dilution of the shareholders’ interest.

The practical effect of this form of executive compensation is a transfer of wealth from the shareholders to the directors and officers who are supposed to hold the shareholders’ interests above their own. This is a legal and accounting issue arising from the nature of the corporation as a trust operated for the benefit of the shareholders.

The extruded form of stock ownership via mutual fund holdings thru 401(k)’s, Keogh’s, IRA’s, ESA’s, MSA’s, etc., has obfuscated the nature of the corporate form in the minds of many people.

All,

I will be as deliberately brief as possible to isolate the KEY point that is being overlooked.

Whether we are talking about stock or widgets, if the seller gives away a unit, or has one destroyed, there is no disagreement that the seller has forgone the marginal REVENUE that a sale would have produced.

What should also be agreed upon, but which has not been directly discussed, is that the seller has also forgone the marginal COST involved in the sale of the marginal unit.

I would find it inconceivable that the actual opportunity cost incurred would be anything other than the DIFFERENCE between the marginal REVENUE and the marginal COST.

But the relationship between the two can vary widely, depending on the details of supply, demand, and the competive structure of the market. The opportunity cost must track these variations. This is precisely the point that I attempted to make in the beginning of this post. I’ll refrain from elaborating further here.

Regards, Don

Mike,

“If you mean by this simply that, by granting rather than selling, some transaction costs associated with selling are avoided, sure, everyone can agree with that. But those are generally very small in comparison to the value of the grants. If you mean something else within this paragraph, something more material, you’ll have to elaborate because I am not tracking your thoughts.”

I definitely mean something else. To explain this I need to back up to fundamentals that no-one usually has any need to be concerned with. Within this explanation, I also address your previous good point about separate sales at separate times.

Imagine that I intend to sell 10 widgets tomorrow.

This is a two part decision, first a decision to sell widgets, and secondly a decision to sell precisely 10, no more, no less. It doesn’t matter if I just sold some last week, because my current decisions take into account the current demand levels.

The second part of the decision is far more complex than anyone is likely to imagine for such a simple result.

If it is a good idea to sell 10, why not 11, or 20, or 100. Note that I am choosing to sell one of several different quantities, not merely selling one after another up to a given point.

The answer to this varies widely with circumstance, so let’s try to categorize some of the possible reasons.

1. I only have 10 available to sell. This is a good reason, and in this case, if I give one away, I have forgone the difference in total revenue between selling 9 units and selling 10 units. The unit prices between the two cases may, or may not, be the same.

2. I have more than 10 available to sell, but selling 11 into the existing market demand would require such a reduction in price that the total revenue received from the sale of 11 would actually be less than the total revenue received from the sale of 10. So I sell 10 and have one left over. Ignoring all the minor technicalities such as perishable goods, and future sales, etc., I can give 1 away without impact.

3. Same as 2. above, except that the total revenue is greater for 11 units than for 10, but the total revenue minus total cost isn’t. This is the case in which marginal revenue is less than marginal cost. When the price was lowered to sell 11 instead of 10, the prices and revenues for the first 10 units were reduced as well, creating the problem. Again, giving away the 11th unsold unit has no impact.

In all of the cases above, I can be a price setter, at least a partial monopolist, and not simply take a market price as in the case of ‘perfect competition.’

In the case of ‘perfect competition’, if I can sell 1, I can sell all that I have at the market price, and by definition, I can’t sell enough to lower the price.

Although I’m certain that I’ve left something out here, I’ll quit for now.

Regards, Don

Cap’n Arbyte,

In the first thread on this topic, I did suggest an accounting for the third case which does what you suggest should be done. I didn’t bother to repeat it for this new discussion thread, so here’s a short recap of my position from that first thread:

(1) Grants of stocks or options ALWAYS have a positive subjective value to ANY valuer. This is an a priori truth that logically follows from the non-negativity of possible future cash flows and the possibility of at least one positive future cash flow (the caveat is necessary to deal with the case of a stock option with a strike price set so high that it is inconceivable that it will ever be in the money).

(2) Grants of stocks or options ALWAYS have an opportunity cost associated with them: the cash that could otherwise be raised by selling rather than granting them.

(3) A rational and responsible accounting system would convey this very real cost to the parties who incur them: the existing stockholders.

(4) A stock or option grant is economically equivalent to two distinct and simultaneous transactions with the same individual: a compensation payment and a sale of a capital instrument: the stock or call option.

(5) Accounting for a stock or option grant as two distinct transactions would communicate the true economic state of a company to its stockholders. Such an accounting would show income reduced in the period of the grant, and subsequent periods would be affected by changes in the ongoing economic (not original) value of all outstanding grants. The latter aspect of this proposed treatment is NOT what FASB is proposing, but FASB hardly ever gets things right!

(6) Failure to do this creates an open invitation to management theft of stockholder values.

(7) The source of this problem was a combination of (i) government intervention in the area of executive compensation targeted at problems caused by its previous interventions which reduced the effectiveness of the market for corporate control, (ii) perverse tax treatment of grants, (iii) failure by FASB and others to recognize the true, dual transaction, nature of grants, and (iv) the willingness of some corporate managers to abuse their stockholders.

I think the combination of numbers (4) and (5) should meet your objection.

Regards,

Mike

Michael,

In (5) why would accounting show a reduced income? I think it would rather show a simultaneous credit and debit of the same magnitude. The company sells shares to raise cash, then immediately pays out the cash just raised. Its net cash position is unchanged.

I’m wary of treating a stock grant as two distinct transactions because I want the accounting to reflect the reality. If there was in fact only one transaction, record it that way. But if it’s recorded as two, one of the transactions is a cash infusion that exactly cancels the cash compensation paid out, leaving the company in an economically unchanged state after the grant is done.

If the message was “stock grants should be expensed, but should also cause an exactly offsetting credit” I wouldn’t be so worried. But is that what you’re saying? That’s not a common message; general thought is that stock grant accounting should show a net decline in the company’s value. But in fact there’s no such decline.

My objection is actually back at (2) and (3), I reject the idea that these opportunity costs are real costs. Opportunity costs here reflect the path _not_ chosen, so they’re _not_ real costs. (Passing up an opportunity to gain is not the same as suffering a loss.)

I don’t view (6) as even relevant to the discussion. The potential for abuse is a concern for stockholders, not accountants.

All,

It seems to me that we are making little progress towards a consensus based upon opportunity cost arguments, so why don’t we just dispense with them? Let’s approach this from another angle.

Suppose the Mises Institute were a private corporation with public stock. For years, it’s been paying its President his reasonable and customary salary of $2,000,000 per year. Living in low-cost Auburn, Lew Rockwell has been able to pay his taxes, lavish consumption goods on his family, and still manage to purchase $1,000,000 in newly issued Mises shares each and every year. Between his salary and his stock purchases, each year Lew puts a dent in Mises’s income to the tune of $2,000,000, decreases its total assets by a net $1,000,000, and increases its number of outstanding shares by some number that depends upon historical Mises Institute share prices.

One year, Lew met with his accountant and tax advisor. Grinning from ear to ear like two Cheshire cats in 3-piece suits, they excitedly said “You know, Lew, we just realized that you could combine your salary payment and stock purchase into a single transaction, net the amount you’re currently paying out of pocket for your stock against your salary, and cut your reported income in half! Not only would this reduce your tax bite, but we wouldn’t have to run $1,000,000 of your salary through income, so reported Mises Institute profit will soar, making you look like the genius that you are for hiring the two of us.”

Being the insightful and ethical guy that he is, Lew responds with “I like it! Except for the part about Mises Institute profits soaring. That’s strikes me as absurd. If we do this, nothing’s really changed: I’ll still be receiving a net $1,000,000 in salary; I’ll still be decreasing the institute’s total assets by $1,000,000 each year; the number of oustanding shares will be the same either way; so I can’t think of a single legitimate reason to assert the the Mises Institute has gained anything by this scheme. You seem to be creating phony income, and I’m not comfortable with that. It’s misleading to the other shareholders. If you can find a way to do this so that it doesn’t distort profits, I’d obviously love to do it for the tax benefits.”

So, guys, What’s wrong with Lew Rockwell?

Regards,

Mike

Don,

You wrote:

I’ll meet you half way. My actual current interest is in opportunity cost per se, as much as in the expensing question. I believe my last two posts contained new angles of attack on the question of opportunity cost for which I’d value your reaction. But that can wait a bit.

I understand that your interest is gradually shifting towards opportunity costs per se, but your submission dealt exclusively with the implication of those costs for an appropriate accounting treatment of stock and option grants. I have comments for you on the views you expressed in your subsequent replies on the demand and supply of a specific entity’s stock, and how opportunity costs play into that. But, first, I think we should drive the final stake through the heart of this separable issue of accounting for grants while we have the chance. Stirring opportunity costs into the brew only serves to cloud the issue, so why do so if we can don’t really have to?

For your example, I found it useful to make some additional assumptions to bring out some of the key points. First, assume that the Mises shares have a price of $100 a share, so 10K shares are required for $1M. Secondly, assume that Lew has a marginal income tax rate of 50% which is applied to all of his cash salary.

You might want to consider a tax rate of 25%, as 50% leaves Lew with nothing to live on should he choose to spend $1,000,000 per year on Mises stock. I intentionally made no assumptions regarding stock prices and tax rates because my argument does not stand or fall based upon their particular values, while expressing those assumptions could become a needless distraction or misleadingly imply a contingent argument.

The stock grants should be considered an exchange, beneficial to both Lew and the existing Mises shareholders. One way to accomplish this is for Lew to effectively buy stock (by salary reduction) at an above market price using pre-tax income. Please review your example taking this possibility into account.
Thanks, Don

There is really no need to do go down this path, as I’ll explain. I suspect your line of argument here is going to be that, by effectively splitting his anticipated tax savings with the Mises Institute (by paying Mises a premium over market for its securities), there actually is a measurable gain to the Mises Institute by entering into this charade, and therefore it should not have to incur any hit to income for amounts spent on Lew’s grants. Let’s assume your suggested tax rate of 50% and that Lew lets Mises capture all the tax benefits. That represents the strongest case for this line of argument. In this best of all cases, you could legitimately argue that 50% of Lew’s salary reduction should somehow find its way into Mises’ financials as an increase in reported profit in each year. This may surprise you, but I agree. However, note that this is precisely what would happen if the institute deducts from income either (a) the amount it actually spends on Lew’s grants (if it repurchases from another shareholder the securities granted to Lew) or (b) the market value of the granted shares (if the institute merely grants Lew newly issued shares).

In other words, expensing stock and option grants as expensing advocates propose would automatically and properly capture these tax sharing effects; all without either Mises’ accountants or the revenuers having to conjecture about the true amount of Lew’s voluntary salary reduction! Mutually beneficial tax savings are clearly irrelevant to the original question of expensing, so we can safely ignore them.

I found it to be of no significance that Lew paid Mises $1M for $1M worth of new stock. Lew could have just bought the stock on the market and it is a separate issue whether Mises wants to sell new stock.

Fair enough, let’s analyze this case as well: Lew’s been buying shares on the market. In this case, the institute can replicate both the economics and accounting results of Lew’s buying existing shares out of his own pocket by (a) reducing his salary, (b) buying existing shares for his grant, and then (c) deducting from income both the cost of purchasing the existing shares and Lew’s reduced salary. Tax sharing effects are captured in this accounting as the difference between Lew’s salary reduction and the funds spent purchasing the granted shares.

By arguing from the principle that identical economics should lead to identical accounting, we still arrive at the same destination. A non-opportunity cost demonstration that fully expensing grants produces an appropriate accounting of profit. Anything less is a deceptive fiction.

We should be finished with this accounting issue, as I believe we are well past the point of QED. Now we can move on to your other opportunity cost conjectures, but not in the context of an expensing practice to the justification of which they are unnecessary (even if some Nobelists appear to assert that they are).

Regards,

Mike

Don,

I know that I’ve taken this out of context, but I doubt that it matters.
I don’t know what actual comparison you are using when you say ‘identical economies’.
I suspect that you are comparing two situations with and without stock grants. I can’t agree that these are identical economies.

I was referring to identical economics, not identical economies. By this term, I mean the following: two transactions have identical economics if they both result in the same cash flows and the same number of outstanding shares; hence, produce the same total assets and the same liabilities. In my opinion, if transactions have identical economics, then they should have identical accounting effects (at least so far as their effects on income and capital). If you reread my comments, you’ll see that I’ve not cross-compared situations with and without grants.

I also think that you agree that one of the things that will reduce shareholder value is allowing an unnecessary amount of taxes to leak out.

As a result, it seems to me an inescapable conclusion that failing to attempt and reach a feasible negotiated exchange with the employee to capture tax benefits is a violation of fiduciary responsibility.

Of course. But what has this to do with anything? Expensing grants will not preclude this. To argue that it would is to argue for nonsense.

The point is that if accounting attempts to equalize one of its results between cases of stock grants vs no stock grants, say income, it is distorting an intermediate result which is likely to be an input to the black box, and will distort the effect of choices on shareholder value.

Accounting is trying to treat economically equivalent transactions identically. There is no single focus on income, although that does get the lion’s share of the attention in the press. There simply is no distortion in expensing grants, in my opinion; in fact, the contrary is true. You have to demonstrate distortion, and not simply assert or assume it.

To the extent that non-current shareholders enter the picture, it is as a parasite.

So current bondholders are parasites? Employees are parasites? Lessors are parasites? All of these non-current shareholders have an absolutely legitimate interest in a company’s accounting, and they are assuredly not parasites. Come on, Don, spend the time to formulate a serious and thought out response.

To the extent that accounting rules attempt to equalize specific intermediate results between different unique companies, at the expense of specific company accuracy in shareholder value, it is a misappropriation of services.

Fortunately, no one is trying to do so.

If outside investors want an accounting process that tries to compare different companies as its primary goal, they are free to contract for and pay for such services. If a company’s existing shareholders, in their own interest, want to additionally provide such services to outside investors, they are free to do so. What cannot happen is that a single process can produce a single set of results that optimally serves both purposes simultaneously.

That is not as feasible as you think. For starters, the required information is not available to outsiders. Beyond that, it is very expensive to produce one, let alone multiple, accounting statements. One per company should suffice.

I’m all for abolishing FASB and ending any SEC influence over accounting. Competing accounting standards are definitely the way to go. Expensing stock and option grants would survive and flourish under that market test, and you and I could debate something else.

Regards,

Mike

Don,

You wrote:

If a new share of stock is granted to an employee, the degree of injury suffered by an existing shareholder can converted to an equivalent number of dollars by asking how many dollars the shareholder would have to spend in theory to buy stock to restore his original percentage ownership in the company. The answer is determined by the current market price of the stock, just the same as the presumed stock compensation expense. One shareholder could buy his stock from anyone, but for all shareholders to restore their positions, the repurchase would have to be from the compensated employees as no other shares are available to be bought.

I don’t think that the above is controversial, but in any case, everything that follows assumes that the expense to be charged for stock compensation is the current market value of the shares granted.

I don’t find that to be at all controversial either. The amount it would cost the corporation to transform the salary plus stock grant back into a pure salary is another way to express the appropriate charge against income.

You then constructed an example of a company whose business is buying and holding perpetuities:

Assume a company whose only business is collecting a constant interest on outstanding loans that never come due. Assume that the interest happens to be $1 per share, for easy reference, but ignore any technicalities like change in share count, possible default, etc.
Also assume the following, with all numbers assumed to be per share …

And follow with three questions:

I think that we would agree that the $0.25 Net Income (with stock expensing) properly quantifies the effective income that the existing shareholder perceives, with a part of it actually being distributed as a cash dividend.

I agree.

I believe that this is the result that the supporters of expensing claim that they want. I also believe that the supporters of expensing are only interested in the reporting of the Net income (with stock expensing) and want to discard the Net income (without stock expensing).

So long as stock and option grants are broken out on a separate line in developing net income, and so long as footnotes or some other disclosures enable them to match them to specific executives, then I would see little reason for stockholders to be interested in net income prior to grant expenses.

Assume that the market price of the stock varies between 0.1X and 10X of the current price. What impact, if any, does this have on the reported results and their proper interpretation?

Note that, with your example’s annual interest income of $1 and a stock price of $25 (you state that $0.25 is 1% of oustanding stock value per share), the after tax market rate of discount must be 4%. If a company without appreciable debt is holding perpetuities, the market value of its assets and hence its equity will float up and down with the after tax rate of discount. For its market value of equity to swing between one tenth and ten times its current value, the after tax rate of discount would have to swing between 0.4% and 40% … quite a bit of volatility!

In any event, so long as the stock grant is defined in terms of the number of shares equal in value to $0.25 and not a fixed number of shares, corporate income would always amount to $0.25 per share. However, the balance sheet would reflect capital gains or losses equal to the annual net income of $0.25 times the difference between the reciprocals of (a) the rate of discount at the end of the current year and (b) the rate of discount at the end of the prior year. Some people might argue that the capital gains and losses should flow through income; that’s a different debate.

This analysis ignores the fact that, in your example, not dividending out all of net income will cause an upward drift in the stock price and, if the difference is used to purchase additional perpetuities, a gradual increase in net income.

Regards,

Mike

Don,

You wrote:

MFD: In any event, so long as the stock grant is defined in terms of the number of shares equal in value to $0.25 and not a fixed number of shares, corporate income would always amount to $0.25 per share….

But this is NOT true, and wouldn’t be significant even if it were true.

Under the additional assumption I had to add to your hypothetical in order to arrive at a plausible and reasonable answer to your own question, my conclusion absolutely is true. If you think it isn’t a valid conclusion, demonstrate its falsity. It is also significant, as you later elaborate upon it at great length.

A given grant will always be a given number of shares and its effective dollar valuation will not only vary day to day, but minute to minute.

If you say so. All of the business owners I know always look at the market price when deciding upon the amount of stock to be granted, or the amounts and strike prices of option grants. To guarantee a manager a fixed number of shares would be inane, especially given the particulars of your hypothetical and volatile company.

If stock grants are to be expensed, the total compensation expense will be a sum of two components, a cash expense component and a stock component expense.

These two components are so different in character that it is a real question as to whether adding them together is even a valid operation.

When cash compensation is paid it is independent of the market value of the company and its effect is invariant once paid out.

In contrast, when stock compensation, some number of shares no matter when and how that number was determined, is granted, the dollar effect is DIRECTLY dependent on the market value of the company.

If the share price changes to one tenth or ten times the value, the $0.25 worth of stock compensation witll become $0.025 or $2.50, respectively. In addition, it is not invariant, and an increase in effective stock compensation today may be fully returned tomorrow as the stock price drops back.

Only if we have to lie down on your Procrustean Bed of assumptions. A compensation program that grants a fixed market value of shares or options has as invariant an initial effect upon income as does fixed cash compensation. In subsequent periods, prior grants have the same effect as would prior stock issues; i.e., no effect upon income at all.

While company income is independent of market value if no stock is granted, this is no longer true if stock is granted AND the income is calculated using the expensed stock compensation.

Only your selective assumptions make this so. Once again, the absurd and predictable result you describe is the very reason I qualified my response with the assumption that managers are intelligent; that they would and easily could maintain a fixed dollar value of the combination of cash and grants.

This means that normal historical uses of the reported income number to determine company profitability, viability and dividend coverage, for example, have become virtually useless unless the stock price is almost completely constant.

Hardly! Under my assumed grant program, this company can be trivially valued at any time as its historical net income of $0.25 divided by the after tax discount rate at that instant.

When the $0.25 stock compensation expense number rises to $2.50, the purpose of this is imply that the shareholder has been devastated by the increase in employee compensation expense. But nothing of the kind has occurred, as the shareholder has had his holding increased by almost 10X in value, less the ownership percentage reduction.

Let’s use your assumption that management grants a fixed number of shares rather than a number currently equivalent to a fixed market value. This is one reason, as I mentioned in my previous post, that some argue for running capital gains and losses through income under a fair, or market, value system of accounting. If this is done, income after grant expenses in the case of your 90 percent drop in the discount rate would be appropriate, and a very large positive number to boot.

The reality comes down to this –

… that your conclusions are entirely contingent upon one of many possible approaches to determining grant amounts being the only one implemented, and that capital gains and losses from changes in the discount rate do not flow through income.

Regards,

Mike

Don,

You wrote:

MFD: Only your selective assumptions make this so. Once again, the absurd and predictable result you describe is the very reason I qualified my response with the assumption that managers are intelligent; that they would and easily could maintain a fixed dollar value of the combination of cash and grants.

Given that it is the responsibility of management to maximize shareholder value, this is not the proper approach.

You seem to be effectively saying that if the stock has temporarily (hopefully) fallen by 90%, mangement should increase the percentage of the company granted in shares from 1% to 10% to maintain constant dollars.

The firm may have no choice but to do so if it wishes to remain in operation. A financial firm, such as the unhedged one you hypothetically constructed, may not be able to retain its management talent if it tries to reduce compensation solely because a critical, but firm exogenous, factor like the market rate of discount increases dramatically. Liquidation may be the best course of action in that case.

In the long term, the concern of shareholders in this regard is how much ownership of the company they have retained.

If the company has to meet market levels of compensation, it makes no difference whether or not they have a smaller share of a company with more assets (stock grants) or a larger share of a company with fewer assets (cash salary). Either way, the stockholders’ net claim to assets is the same, as we’ve already established and don’t need to rehash.

If employees are interested in receiving stock at all, an increase from 1% to 2% may be sufficient as they presumably know that the stock is likely to rebound, if in fact it is.

If it were actually the case that employees anticipate a stock rebound, then a substitution of a larger number of low cost (in terms of current market value) option grants with an appropriately high strike price in place of a smaller number of stock grants would be a very logical move. However, this situation surfaces no new reason to question the accounting of grants.

Assume the company is a recipient of patent royalties, since you have been making complicating assumptions about interest.

I made no assumptions about interest rates; you did. I merely pointed out the implicit assumptions in your own construct.

When cash and stock compensation are summed, this is effectively a lossy data compression, resulting in less, not more, information on the state of the business operations of the company itself.

There is present just as much information as there would be had compensation been paid entirely in cash and a portion of that expenditure been funded by issuing new shares to either a third party or to executives. There would be far more information on the state of the business than there would be have been under the common practices of the 1990s. In any event, I responded to you with the suggestion that grant costs be reported on different lines, that enough information be presented so that these costs could be matched to grant recipients, and that the total number of shares be properly adjusted — even in the case of option grants. Why are you now complaining about an additional line combining these very real grant costs with cash compensation outlays, as though I was proposing an invalid operation like adding apples to oranges?

It is the shareholders who can imagine using their own funds to buy back enough shares to restore their ownership of the company lost to grants. This represents the current degree of their injury. Every day this imaginary calculation will yield a different dollar result, but over the long term, it is the percentage losses of ownership that count.

Stockholders are interested both in their ultimate dilution and in properly allocating the cost of that dilution to each production period. What you call an imaginary calculation is a very meaningful calculation; one without which it would not be possible rationally and responsibly guide a company. It also appears as though you are conflating what Buchanan called choice-influencing costs with choice-influenced costs. What matters for decision making are the choice-influencing costs at the time each compensation bundle is determined and granted.

When a company grants new shares, its business results are not affected, but the benefits, if any, go to a different distribution of people.

Now you are returning to your fallacious argument that stock grants do not affect business results, presumably because you believe that they are not granted in lieu of cash compensation. But for the substitution of grants for salary, company assets would be reduced by current cash compensation, and that can hardly be described as not affecting business results.

Let’s recap. Without denying the validity of opportunity cost arguments, I asserted that it is not necessary to resort to opportunity cost arguments to establish the case for expensing stock and option grants. You responded with your own non-opportunity cost based argument for expensing grants. Therefore, going forward, I am going to assume that you now agree that grants should be expensed; that your original stance was made in error. If you cannot admit to that by now, then I am done arguing with you on this topic. I realize that there still remain accounting implications that trouble you, largely revolving around the question of whether or not capital gains and losses should flow through the income statement. I would run them through income were I king of the world, but I really don’t care to debate that tangential issue. If you can now admit that stock and option grants should be expensed, then we can move on to your other claim that issuing shares entails no opportunity cost. If not, my own opportunity costs compel me to move on and let other readers reach their own conclusions.

Regards,

Mike

nice way to explainn opportunity cost Stock Value