This, from the San Diego Union-Tribune: another tech company agrees with Private investment Custodian idea to build a market for derivative instruments designed to mimic a value for employee stock options.
“It’s a great idea that has the potential to bring some integrity to the valuation process,” said William Keitel, Qualcomm’s chief financial officer.
This is important for at least one reason: “integrity” is not a concept that tech firms have brought to the table when discussing stock option compensation. Ever.
As for being a “great idea,” Coca-Cola’s plan to have multiple investment bankers value its stock options as a way around using the Black-Scholes option pricing model was also heralded as a great idea. But don’t forget that Coke scuttled the plan. According to accounting folklore, one of the reasons was that the investment bankers intended to estimate the value of the options using – you guessed it – the Black-Scholes option pricing model. Ultimately, the values derived from such hiring such expensive help would be no different than if the accounting staff plopped their estimates into a spreadsheet designed to do such calculations – so Coke scrapped the idea.
A couple days ago, Mr. Myron Scholes – that’s his name in “Black-Scholes” – tossed some cold water on the Cisco system, questioning the genuineness of a market for these instruments – and wondering that “somewhere along the line the options [underlying the derivatives] would still need to be valued through an established options-pricing model.” Just like Coca-Cola discovered.
Deja vu all over again. But this time it’s different. (Maybe the five most dangerous words in the world.) This time, it’s the tech companies are trying to present their version of reality and not some mild-mannered beverage maker. Intel made noises last week that it found the Cisco system “a pretty good idea;” now Qualcomm; and the Union-Tribune article quotes Dell’s CFO as saying it’s interesting. If the SEC buys off on the approach, the tech companies will bray loud and long that the idea works until they convince people it works – even if it doesn’t.
Remember, this is the same bunch that once said options couldn’t be valued – at all. They said that expensing options was double-counting when in fact it was no-counting. They fooled some of the people all of the time. And they’ll do it again.
Maxtor Corporation filed a non-reliance 8-K this morning, due to an error in recording quarter-end inventory last March. The error itself was a humbler: goods worth $2 million had been shipped FOB destination at the end of the quarter, meaning they belonged to Maxtor until they arrived at the customer’s door. A journal entry had been properly set up to keep the goods in inventory, and out of cost of goods sold at period end – but the entry was inadvertantly reversed when it was recorded. The inventory was understated, and cost of goods sold was overstated.
How much? Inventory was understated by $4 million (1.8%); cost of goods sold was overstated by $4 million (0.4%). Not much of a balance sheet effect. But on the income statement, net loss was overstated by $4 million (16.7%) and the (ever-important) net loss per share was overstated by $0.02 per share (20%). In the rock ‘n roll 90’s, maybe that would have been shrugged off; maybe not. (Not that it would have been right.) But precision was definitely looser when it came to materiality.
As mentioned earlier, materiality is apparently being dialed down after the first round of internal control reviews – and when the SEC releases its new missive on materiality, it’d be reasonable to expect to see a lot more restatements. Need more evidence of increased precision in figuring materiality? Look no further than the SEC’s comments on lease accounting and the restatements that ensued. Make no mistake about it: 2005 will set a record when it comes to sheer volume of restated financials. Sticking to standards and a narrower view of materiality are reasons why.
A Retro ’90’s Event
CFO.com reports that Marsh & McLennan Companies has filed an amended proxy statement that asks shareholders to approve a repricing of options.
The plan would exchange way out-of-the-money options for fewer new ones, issued at current prices.
According to the CFO.com story, the filing states that “This would help us to retain key staff, motivate and reward employees for their contributions to our future success and reduce a substantial amount of stock option overhang.”
It’s one thing – and a good one, at that – to try reducing the option overhang. But must it be done by a repricing of existing options? The stockholders who were around when the options were originally issued don’t get to reprice their stock.