Monday, April 19, 2004

Self-Serving Business Spin

I'm a (very small) Intel shareholder, and they are a pretty arrogant bunch, so I might as well get a column out of having read the annual report.

In following the current dispute over expensing options, I recalled that Intel lobbied me back in 1993 or 1994 about signing on to a House resolution urging (pressuring) FASB not to require expensing of options.  My chief of staff sat through the presentation and after it was all over, asked the Intel guy if they had any ideological qualms about coming to the government with this issue; didn't that go against their usual mantra that they wanted only government to get out of the way of business?  The Intel guy looked sheepish, but quickly got back on message about how expensing options would be the end of our economy, or Western Civilization.  I guess we learned that for many businesses, principles are one thing but money's another.

I didn't understand the issue all that well in 1993, and I would have been happy to do anything that was so ostensibly "pro-business" but, thankfully, I think big business couldn't get what they wanted out of the House but the Senate was more than happy to do their bidding.  The business lobbyists got the Senate to force the SEC and FASB to back down, and then the business types could go back to complaining about government interference and how it was costing them all sorts of money.

So much for my anecdote, here's the column. It's an odd headline, but again, I don't write 'em. Too obscure? Short version: On this issue, go with Warren Buffett and not Craig Barrett. Newspaper version available here.

East Valley Tribune, Apr. 18, 2004

Business types love to trash politicians’ ethics and honesty. But when it comes to defending their own self-interest in not expensing options, Intel’s 2003 annual report proves that some business leaders make politicians look like rank amateurs.

Intel management doesn’t want stock options’ cost deducted from reported income because it’s a “theoretical expense.” Yet Intel’s financial statements are full of theoretical entries, like assumed pension plan asset growth, depreciation, and goodwill. Only when calculating their own compensation does management suddenly doubt their estimating abilities.

Management also opposes expensing options because the cost “is accurately and transparently” reported -- in tiny type, partially in footnote 1 on page 6 and partially in footnote 12 on page 19 of a 34-page financial statement. If that’s “transparent,” I’m the Queen of England. You have to find and read both footnotes to discover how much of the company employees gave themselves, and how Intel’s reported earnings were 15 percent less once you deduct option costs.

“Accuracy,” however, is relative. Intel says the footnotes “accurately” reflect the cost. But in opposing expensing, management complains that current accounting methods aren’t accurate. Intel apparently believes current accounting rules are accurate enough for footnotes, but not for the income statement -- and press releases.

If current accounting methods upset Intel, they have only themselves to blame. When the Financial Accounting Standards Board last considered requiring expensing of options, corporate America responded in the only way they know, by lobbying Congress for special treatment. Congress (led by Joe Lieberman) responded, and FASB backed down.

The companies were so concerned with not expensing option costs that they didn’t much care what valuation method FASB chose; the companies knew that whatever appears in the footnotes didn’t matter much. Now that costs might emerge from the footnotes to the actual income statement, valuation methods suddenly matter again.

Intel management also opposes replacing options with restricted stock, or requiring performance-based options. Why, they say, linking options to Intel outperforming a stock index or its peer companies means the stock price could fall, but because it decreased less than its peers or the index, employees still could earn bonuses!

Forget “could” -- that’s how it actually works now. Yes, it’s technically true, as management claims, that options “provide no benefit to the employee in the event that the stock price declines below the stock option grant price.” This is true in the same way that Bill Clinton “did not have sex with that woman.”

After Intel stock did decline, in November, 2002 the company issued supplemental options to employees whose 2000 and 2001 options had exercise prices above the market price. Management justified the new options as needed “to retain employees, due to competitive market conditions.” Shareholders, of course, did not get a “do-over.”

The stock declined; prior options went “underwater” and became worthless; but the company rewarded employees anyway by giving them new, lower-priced options -- because competitors did it, too!

Options don’t align employee incentives with shareholders, because options are “heads we both win, tails only you lose.” Employees can reap huge awards but risk nothing of their own, while shareholders always risk loss as well as gain.

That options are an expense; that options don’t perfectly align management’s interests with shareholders; that options can be (and have been) abused; that management presumes they’ll do better, at shareholder expense, if options aren’t expensed -- all seem perfectly obvious.

But what’s less obvious is that many of our so-called “business leaders” have nothing on our most self-interested politicians. Intel’s proxy statement proves that nobody who works there has any right to criticize politicians for double-talk and spin.

You guys are the champs, hands down.

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