Academics REUVEN BRENNER and DONALD LUSKIN argue in today’s Wall Street Journal that when stock options are issued, they should be treated for accounting purposes, not as nothing (the traditional method) nor as an immediate but estimated expense (the current “reform” proposal), but as a contingent future liability that becomes an expense when exercised. (The article is available online only for subscribers). Their argument makes sense, and for another reason they don’t mention: expensing options when exercised means that a company’s income statement will take a hit (and be expected to take a hit) immediately after any big run-up in the stock that causes options to be exercised in large numbers. That should provide something of a check to excess enthusiasm, because big-time inside selling will trigger an instant dip. (The downsides: (1) until management absorbs this lesson, there would be more spike-and-drop patterns leading to more lawsuits, and (2) some execs could be legally trapped from selling by insider trading laws, because their decision to exercise options could, itself, be material nonpublic information about the future financial results of the company).
UPDATES: First of all, I mistakenly identified Donald Luskin as an academic, which he isn’t. Second, Prof. Brenner was kind enough to email me to point out that he had considered the “hit to the income statement” point in his original draft of this article, which had to be shortened to fit the WSJ’s space constraints.