Dr. Rodgers' in a Speech to Silicon Valley Rally Supporting Employee Equity: Let Our Options Go | Cypress Semiconductor
Dr. Rodgers' in a Speech to Silicon Valley Rally Supporting Employee Equity: Let Our Options Go
Dr. Rodgers' in a Speech to Silicon Valley Rally Supporting Employee Equity: Let Our Options Go
Let Our Options Go!
March 25, 1994
A Silicon Valley Rally Supporting Employee Equity
Dr. T.J. Rodgers
President & CEO
Cypress Semiconductor Corporation
San Jose, California
FASB: BUREAUCRACY AT ITS FINEST
What is FASB, anyway? The Financial Accounting Standards Board. To whom do they report? They are an independent organization funded by private industry. Believe it or not, we actually pay them to mess up our accounting rules. Although the Securities and Exchange Commission is legally in control of accounting rules, the SEC has delegated to FASB the right to set accounting rules for private industry. Consequently, I would call FASB a government-mandated bureaucracy that controls how companies report finances. My comments incorporate portions of FASB's mission statement, as presented in their annual report, to illustrate the fact that in attacking stock options, FASB has violated three of its own stated missions.
Seven Commissioners run FASB. I prefer to call them Commissars. They pontificate from Connecticut on their holy grail, "Accounting Principles." They choose not to disclose their salaries in their annual report, but my best information is that the Accounting Principles-edicting business pays $300,000 to $500,000 per year. Apparently, the salary disclosure laws that apply to companies do not apply to them.
Let me give you some facts about the Commissars: Not one of them ever started a company. Not one of them ever ran a company. Not one of them ever was the chief financial officer of a company. Most of them have been mired as accountants for their entire careers, never once having worked in a company that created real manufacturing jobs. Why would we even contemplate putting the fate of Silicon Valley in the hands of these business rookies?
THE FASB ATTACK
Specifically, what is FASB's proposal? FASB is attempting to force companies to expense stock options. "Expense" means to record a loss on the company's income statement. For example, the $100 million Cypress pays its employees each year is expensed as a loss. We also give stock options to each of our 1,500 employees, both at hiring and annually after that. We grant those stock options at market value--for example, at today's price of about $20 per share. If employees exercise and sell their options the day they are granted, they make nothing; therefore, employees typically hold their options for years until (and if) they gain value. As they help build the company, the employees share in the value that they have helped to create. That's how Silicon Valley got built: with stock options.
FASB wants to force companies to declare a loss whenever they issue stock options to their employees. FASB has taken this position ostensibly because of the correctness of the Accounting Principle that options have value the day they are granted; therefore, issuing them represents an expense. The real driving force behind FASB's position is political blackmail. The bad guy is Senator Carl Levin of Michigan. Levin does not like high executive salaries. That's okay. This proposed accounting change is his misguided effort to cut back executive salaries by making it more expensive for companies to give out stock options. By the way, the salaries Levin is attacking never happened in Silicon Valley--not even for John Sculley. We are talking about some immense compensation, over $100 million a year. If Levin wants to stop that, let him do it without damaging Silicon Valley's wonderful economic machine in the process.
Levin is succeeding by mounting a political attack on the supposedly non-political FASB organization. He said, in effect, that if FASB does not change stock option accounting, he will pass a bill to force them to do it. Under that threat, FASB agreed to revive an old stock option expensing proposal that it had killed for good cause several times. That is the potential catastrophe we are currently facing. And, in a true backroom political deal, Levin has agreed to put his bill on hold, while waiting for FASB to implement the rule change that he demands. That's why over at the Hyatt [Hotel, where the FASB hearings are being held], the Commissars are not listening today; they are not here to listen. They are here to tell us what they must do to keep Levin from meddling with their accounting rules.
THE IMPACT ON SILICON VALLEY
I will use Cypress as an example because I have the numbers at my fingertips, but the new FASB edict would hurt most Silicon Valley companies similarly. We issue about 2 million stock options per year to our employees. Those options, at face value, are worth about $20 a share times 2 million shares, or about $40 million. FASB wants us to declare as a loss the value of those options as we give them out. The write-off value for a typical high-tech stock option amounts to about 50% to 60% of its face value, as determined by the obscure Black-Scholes option-pricing model. Therefore, Cypress would be forced to lose about $20 million a year, on paper, just to keep our employee stock option program. That represents about one-third of our total profits this year, according to analysts' estimates. Our earnings would then collapse by 33% forever--and you know what that means on Wall Street, where even one bad quarter carries a severe penalty.
The most unreasonable aspect of the FASB proposal is that it would impose double taxation. When Cypress issues 2 million options to its employees, the number of outstanding shares increases by 5% from 40 to 42 million, causing our earnings per share to drop by 5%, a significant reduction in reported earnings--the price we already pay to make our employees shareholders. FASB proposes that we pay twice: first through dilution and a second time through stock option write-offs.
Does someone benefit by these proposed changes? Ordinarily, when the government taxes corporate profits, the money benefits some program. At least you can say, "There is a rocket up there with my name on it." But the answer here is, "No!" No one gains anything for the paper losses imposed on high-tech companies. It's not even a win-lose game; it's a lose-lose game, with no benefit to anyone.
FASB claims they must mandate the expensing of options because of the sacred Accounting Principles. FASB's Chief Commissar, Dennis Beresford, says, "We are aware of the concerns that small businesses have. But we feel initiating stock options without any cost gives the issuing company an unfair advantage." Well, Mr. Beresford, what advantage would you like us to have, relative to our Japanese competitors? I want a huge unfair advantage, not just an ordinary unfair advantage. That's called making America competitive. Wake up! If the Japanese industry-government consortium, MITI, used a financial tool to make Japan more competitive, we would use it, not argue with our bureaucrats about why Japan should maintain its "unfair advantage."
The proposed FASB edict on stock options is also totally inconsistent with a prior FASB edict on a common financial instrument called a convertible debenture--debt which is convertible to stock. Issuers of convertible debentures must show the interest expense of their debt as a loss, or count extra shares in their earnings per share calculation, but not both. Will FASB change over to "double taxation" of convertible debentures, also?
We always treat FASB directors as experts who understand economics, but an examination of the practical outcome of their proposed accounting changes belies that image. For example, let's suppose company A gives out 2 million options at $20, and their stock later goes up to $40. The employees make $20 million, and company A writes off $20 million. Now, let's suppose that company B gives out $20 million worth of options, but their stock price remains unchanged, and no employee ever makes a penny. Company B also writes off the same $20 million. Now let's suppose that company C also grants $20 million worth of options, but their stock price remains unchanged, and no employee ever makes a penny. Company B also writes off the same $20 million. Now let's suppose that company C also grants $20 million worth of options to its employees, and that the employees all quit the next month, giving their options back to that company. Company C also writes off $20 million, an economic non sequitur.
Here is a delightful quote on this topic from FASB's Ms. Elizabeth Fender (the "assistant project leader" for option expensing): "Under no circumstances do you ever reverse an expense. There can be no adjustment in option expense after the grant date. Even [option] cancellations do not result in a reversal." Thus, even though 80% of Silicon Valley companies issue options that never gain value, they still would have to write off those options, impairing their earnings. And then Wall Street would put its money elsewhere, in other valleys, rather than here. Instead of inflicting this damage on Silicon Valley, FASB should read its own mission statement: "Information must report economic activity as accurately as possible." Would investors in companies A, B, and C get an accurate economic comparison? Obviously not.
THE IMPACT ON AMERICAN COMPETITIVENESS
Looking beyond Silicon Valley, what is the impact of option expensing on America? First, privately held start-up companies would be forgiven losses on stock option grants because their boards of directors are typically sophisticated venture capitalists who understand the value of stock options. Second, since the Fortune 100 companies don't give stock options to their rank and file employees, the change wouldn't matter to them, either. That leaves the middle--and it's a big middle--ranging all the way from newly public $50-million companies to companies as large as Intel. Those are the companies that will be damaged by this FASB proposal. It's going to clobber companies exactly at the point in their life cycle when they are producing the greatest number of new jobs. Employment at the Fortune 100 is shrinking. And pre-public start-ups are too small to create large numbers of jobs. This accounting rule change seems to be optimized to destroy the greatest number of jobs.
Chief Commissar Dennis Beresford addressed that topic with my all-time favorite FASB quote, one which demonstrates total detachment and sublime arrogance: "We are finding more people dislike than like this [rule change] document. But that's very often because they are looking at economic consequences, not accounting principles." So here we are, in this era of high unemployment, witnessing the high priests of the double-entry ledger preparing to sacrifice job-generating entrepreneurial companies on the altar of Accounting Principles. Let me read you another FASB mission statement:
"To promulgate standards, only when the expected benefits exceed the perceived costs." How can they propose to damage America's most progressive companies with no tangible benefit, and claim that the "expected benefits exceed the perceived costs," as their own mission statement demands?
IT'S LONELY OUT THERE
Who's against FASB? The American Institute of Certified Public Accountants (AICPA). Their former Chairman, Samuel Derieux, said, "Accounting standards based on common sense and practicality are often superior to highly technical standards. This is particularly applicable when, as in the case of stock options, the common sense standard provides the information that the public needs." Here Mr. Derieux is referring to the FASB claim that option expensing option grants, or what Senator Levin calls "stealth compensation." Levin misses three obvious points: (1) shares outstanding, including options, are reported to investors quarterly and also dilute the reported earnings per share, (2) executive compensation, including stock option gains, is reported to investors annually, and (3) the obvious--shareholders must approve the granting of those options by vote before they are issued! How much more information do investors need? Consider the ridiculous proposition that would be put to shareholders if FASB actually chose to consult them on the issue: "Vote ‘yes' or ‘no': the company whose shares you own should report forever lower earnings, due strictly to an accounting change, in order to provide you with a fourth source of information on stock option grants." It's clear that this FASB folly would also hurt high-tech shareholders.
Who's against FASB? The big six accounting firms, every one of them. The SEC itself has recommended that option expense appear in a footnote, but not in the profit and loss statement. The Council of Institutional Investors, a group that regularly criticizes astronomical executive salaries, is also against the FASB proposal.
Who's against the FASB? The NASDAQ Stock Market, the American Electronics Association, the National Venture Capital Association, the National Association of Manufacturers, the Senate Banking Committee, and the Secretary of the Treasury. Connecticut Senator Joseph Lieberman has introduced a bill that will nullify the FASB edict. Lieberman says, "As a matter of abstract accounting theory, the FASB approach to stock option accounting may be defensible, but from the public policy, job creation and job competitiveness perspective, it is simply unnecessary and unusually disruptive."
So, what do you say if you are the number-two man at FASB and most of the world is against you? Here's Vice-Premier James Leisenring's response, "Despite what you may have heard, we are reconsidering accounting for stock option write-offs because our constituents, including the AICPA, the SEC, most of the major accounting firms, and several corporations asked us not to do it, not because of political pressure." That statement doesn't pass the red-face test! Let me read another part of the FASB mission statement: "To weigh carefully the options of constituents." I recommend a modification of that mission statement: "To weigh disproportionately the opinion of a constituent--especially if he is a hostile Senator who is threatening to break into your Accounting Principles-edicting monopoly."
WHAT WE WANT
We demand that FASB withdraw its absurd accounting rule proposal. We remind this arrogant bureaucracy that accountants exist to serve people, their economy, and their businesses--not vice-versa. And we warn FASB that, although we in Silicon Valley do not engage in politics much because we are too busy with our technology, California does have the largest Congressional delegation, and we will ask them to intercede to eliminate this FASB mistake if the Commissars are too headstrong to rectify their own error. So, Mr. Beresford, we are not asking--we are demanding--that you let our options go!