Berkshire Hathaway will be happy to receive options in lieu of cash for many of the goods and services that we sell corporate America.
The serial also introduces the name of the Doctor's home planet, Gallifrey. He agrees to give futuristic weaponry to the warrior Irongron David Daker and his men in exchange for Linx being given shelter to perform repairs on the damaged spaceship. In the Middle Ages , the bandit Irongron and his aide Bloodaxe, together with their rabble of criminals, find the crashed spaceship of a Sontaran warrior named Linx. They strike a bargain, though Irongron remains suspicious. The Third Doctor and Brigadier Lethbridge-Stewart are investigating the disappearance of several scientists from a top secret scientific research complex.
They do not know Linx has used an Osmic Projector to send himself forward to the 20th century and has kidnapped the scientists, then hypnotised them into making repairs on his ship. The Projector only lets him appear in another time for a brief period. While the Doctor investigates he meets an eccentric scientist called Rubeish and a young journalist called Sarah Jane Smith , who has infiltrated the complex by masquerading as her aunt. Irongron has stolen his castle from an absent nobleman, and relations with his neighbours are appalling.
Indeed, the mild Lord Edward of Wessex has been provoked into building an alliance against him and, when this is slow in developing, sends his archer Hal on an unsuccessful mission to kill Irongron. Irongron is in a foul mood when a captured Sarah is brought before him. His mood improves when Linx presents him with a robot knight which is then put to the test on a captured Hal. The ensuing confusion lets both Hal and Sarah flee, and they head for Wessex Castle.
Meanwhile, the Doctor has realised both that Sarah is in the time period and has been captured, and also that she previously supposed him to be in league with Irongron. He makes contact with Rubeish and finds the human scientists in a state of extreme exhaustion.
Linx catches the Doctor in the laboratory once more, but this time is rendered immobile when a lucky strike from Rubeish hits his probic vent — a Sontaran refuelling point on the back of their necks which is also their main weakness.
Rubeish and the Doctor use the Osmic Projector to send the scientists back to the twentieth century. A recovered Linx now determines his ship is repaired enough to effect a departure. Once more he encounters the Doctor, and they wrestle in combat.
A crazed and half drugged Irongron arrives and accuses Linx of betraying him: As Linx enters his spherical vessel Hal arrives and shoots him in the probic vent, and the Sontaran warrior falls dead over his controls, triggering the launch mechanism. Knowing the place is about to explode when the shuttle takes off, Bloodaxe awakes and rouses the remaining men and tells them to flee, while the Doctor hurries the last of his allies out of the castle.
The original outline for the serial was humorously submitted to the production office in the form of a "Field report from Sontaran Field Marshal Hol Mes, to Terran Cedicks". Location shooting of both Wessex Castle and Irongron's castle was done at Peckforton Castle , in Cheshire , utilising different views.
How legitimate is an accounting standard that allows two economically identical transactions to produce radically different numbers Fallacy 2: Option-pricing models may work, they say, as a guide for valuing publicly traded options.
But they cant capture the value of employee stock options, which are private contracts between the company and the employee for illiquid instruments that cannot be freely sold, swapped, pledged as collateral, or hedged.
It is indeed true that, in general, an instruments lack of liquidity will reduce its value to the holder. But the holders liquidity loss makes no difference to what it costs the issuer to create the instrument unless the issuer somehow benefits from the lack of liquidity.
And for stock options, the absence of a liquid market has little effect on their value to the holder. The great beauty of option-pricing models is that they are based on the characteristics of the underlying stock. Thats precisely why they have contributed to the extraordinary growth of options markets over the last 30 years. The Black-Scholes price of an option equals the value of a portfolio of stock and cash that is managed dynamically to replicate the payoffs to that option.
With a completely liquid stock, an otherwise unconstrained investor could entirely hedge an options risk and extract its value by selling short the replicating portfolio of stock and cash. In that case, the liquidity discount on the options value would be minimal. And that applies even if there were no market for trading the option directly. Therefore, the liquidityor lack thereofof markets in stock options does not, by itself, lead to a discount in the options value to the holder.
Investment banks, commercial banks, and insurance companies have now gone far beyond the basic, year-old Black-Scholes model to develop approaches to pricing all sorts of options: Options traded through intermediaries, over the counter, and on exchanges.
Options linked to currency fluctuations. Options embedded in complex securities such as convertible debt, preferred stock, or callable debt like mortgages with prepay features or interest rate caps and floors. A whole subindustry has developed to help individuals, companies, and money market managers buy and sell these complex securities.
Current financial technology certainly permits firms to incorporate all the features of employee stock options into a pricing model. A few investment banks will even quote prices for executives looking to hedge or sell their stock options prior to vesting, if their companys option plan allows it.
Of course, formula-based or underwriters estimates about the cost of employee stock options are less precise than cash payouts or share grants. But financial statements should strive to be approximately right in reflecting economic reality rather than precisely wrong. Managers routinely rely on estimates for important cost items, such as the depreciation of plant and equipment and provisions against contingent liabilities, such as future environmental cleanups and settlements from product liability suits and other litigation.
When calculating the costs of employees pensions and other retirement benefits, for instance, managers use actuarial estimates of future interest rates, employee retention rates, employee retirement dates, the longevity of employees and their spouses, and the escalation of future medical costs. Pricing models and extensive experience make it possible to estimate the cost of stock options issued in any given period with a precision comparable to, or greater than, many of these other items that already appear on companies income statements and balance sheets.
Not all the objections to using Black-Scholes and other option valuation models are based on difficulties in estimating the cost of options granted. For example, John DeLong, in a June Competitive Enterprise Institute paper entitled The Stock Options Controversy and the New Economy, argued that even if a value were calculated according to a model, the calculation would require adjustment to reflect the value to the employee.
He is only half right. By paying employees with its own stock or options, the company forces them to hold highly non-diversified financial portfolios, a risk further compounded by the investment of the employees own human capital in the company as well.
Since almost all individuals are risk averse, we can expect employees to place substantially less value on their stock option package than other, better-diversified, investors would. Estimates of the magnitude of this employee risk discountor deadweight cost, as it is sometimes calledrange from 20 to 50, depending on the volatility of the underlying stock and the degree of diversification of the employees portfolio.
The existence of this deadweight cost is sometimes used to justify the apparently huge scale of option-based remuneration handed out to top executives. A company seeking, for instance, to reward its CEO with 1 million in options that are worth 1, each in the market may perhaps perversely reason that it should issue 2, rather than 1, options because, from the CEOs perspective, the options are worth only each. We would point out that this reasoning validates our earlier point that options are a substitute for cash.
But while it might arguably be reasonable to take deadweight cost into account when deciding how much equity-based compensation such as options to include in an executives pay packet, it is certainly not reasonable to let dead-weight cost influence the way companies record the costs of the packets. Financial statements reflect the economic perspective of the company, not the entities including employees with which it transacts.
When a company sells a product to a customer, for example, it does not have to verify what the product is worth to that individual. It counts the expected cash payment in the transaction as its revenue.
Similarly, when the company purchases a product or service from a supplier, it does not examine whether the price paid was greater or less than the suppliers cost or what the supplier could have received had it sold the product or service elsewhere. The company records the purchase price as the cash or cash equivalent it sacrificed to acquire the good or service. Suppose a clothing manufacturer were to build a fitness center for its employees. The company would not do so to compete with fitness clubs.
It would build the center to generate higher revenues from increased productivity and creativity of healthier, happier employees and to reduce costs arising from employee turnover and illness. The cost to the company is clearly the cost of building and maintaining the facility, not the value that the individual employees might place on it. The cost of the fitness center is recorded as a periodic expense, loosely matched to the expected revenue increase and reductions in employee-related costs. The only reasonable justification we have seen for costing executive options below their market value stems from the observation that many options are forfeited when employees leave, or are exercised too early because of employees risk aversion.
In these cases, existing shareholders equity is diluted less than it would otherwise be, or not at all, consequently reducing the companys compensation cost. While we agree with the basic logic of this argument, the impact of forfeiture and early exercise on theoretical values may be grossly exaggerated.
The Real Impact of Forfeiture and Early Exercise Unlike cash salary, stock options cannot be transferred from the individual granted them to anyone else. Nontransferability has two effects that combine to make employee options less valuable than conventional options traded in the market. First, employees forfeit their options if they leave the company before the options have vested. Second, employees tend to reduce their risk by exercising vested stock options much earlier than a well-diversified investor would, thereby reducing the potential for a much higher payoff had they held the options to maturity.
Employees with vested options that are in the money will also exercise them when they quit, since most companies require employees to use or lose their options upon departure. In both cases, the economic impact on the company of issuing the options is reduced, since the value and relative size of existing shareholders stakes are diluted less than they could have been, or not at all.
Recognizing the increasing probability that companies will be required to expense stock options, some opponents are fighting a rearguard action by trying to persuade standard setters to significantly reduce the reported cost of those options, discounting their value from that measured by financial models to reflect the strong likelihood of forfeiture and early exercise.
Current proposals put forth by these people to FASB and IASB would allow companies to estimate the percentage of options forfeited during the vesting period and reduce the cost of option grants by this amount.
Also, rather than use the expiration date for the option life in an option-pricing model, the proposals seek to allow companies to use an expected life for the option to reflect the likelihood of early exercise.
Using an expected life which companies may estimate at close to the vesting period, say, four years instead of the contractual period of, say, ten years, would significantly reduce the estimated cost of the option. Some adjustment should be made for forfeiture and early exercise.
But the proposed method significantly overstates the cost reduction since it neglects the circumstances under which options are most likely to be forfeited or exercised early. When these circumstances are taken into account, the reduction in employee option costs is likely to be much smaller. Using a flat percentage for forfeitures based on historical or prospective employee turnover is valid only if forfeiture is a random event, like a lottery, independent of the stock price.
In reality, however, the likelihood of forfeiture is negatively related to the value of the options forfeited and, hence, to the stock price itself. People are more likely to leave a company and forfeit options when the stock price has declined and the options are worth little.
But if the firm has done well and the stock price has increased significantly since grant date, the options will have become much more valuable, and employees will be much less likely to leave. If employee turnover and forfeiture are more likely when the options are least valuable, then little of the options total cost at grant date is reduced because of the probability of forfeiture.
The argument for early exercise is similar. It also depends on the future stock price. Employees will tend to exercise early if most of their wealth is bound up in the company, they need to diversify, and they have no other way to reduce their risk exposure to the companys stock price. Senior executives, however, with the largest option holdings, are unlikely to exercise early and destroy option value when the stock price has risen substantially.
Often they own unrestricted stock, which they can sell as a more efficient means to reduce their risk exposure. Or they have enough at stake to contract with an investment bank to hedge their option positions without exercising prematurely. As with the forfeiture feature, the calculation of an expected option life without regard to the magnitude of the holdings of employees who exercise early, or to their ability to hedge their risk through other means, would significantly underestimate the cost of options granted.
Option-pricing models can be modified to incorporate the influence of stock prices and the magnitude of employees option and stock holdings on the probabilities of forfeiture and early exercise. The actual magnitude of these adjustments needs to be based on specific company data, such as stock price appreciation and distribution of option grants among employees.
The adjustments, properly assessed, could turn out to be significantly smaller than the proposed calculations apparently endorsed by FASB and IASB would produce. Indeed, for some companies, a calculation that ignores forfeiture and early exercise altogether could come closer to the true cost of options than one that entirely ignores the factors that influence employees forfeiture and early exercise decisions.
Stock Option Costs Are Already Adequately Disclosed Another argument in defense of the existing approach is that companies already disclose information about the cost of option grants in the footnotes to the financial statements.
Investors and analysts who wish to adjust income statements for the cost of options, therefore, have the necessary data readily available. We find that argument hard to swallow. As we have pointed out, it is a fundamental principle of accounting that the income statement and balance sheet should portray a companys underlying economics. Relegating an item of such major economic significance as employee option grants to the footnotes would systematically distort those reports.
But even if we were to accept the principle that footnote disclosure is sufficient, in reality we would find it a poor substitute for recognizing the expense directly on the primary statements. For a start, investment analysts, lawyers, and regulators now use electronic databases to calculate profitability ratios based on the numbers in companies audited income statements and balance sheets.
An analyst following an individual company, or even a small group of companies, could make adjustments for information disclosed in footnotes. But that would be difficult and costly to do for a large group of companies that had put different sorts of data in various nonstandard formats into footnotes. Clearly, it is much easier to compare companies on a level playing field, where all compensation expenses have been incorporated into the income numbers.
Whats more, numbers divulged in footnotes can be less reliable than those disclosed in the primary financial statements. For one thing, executives and auditors typically review supplementary footnotes last and devote less time to them than they do to the numbers in the primary statements. As just one example, the footnote in eBays FY annual report reveals a weighted average grant-date fair value of options granted during of Just how the value of options granted can be 63 more than the value of the underlying stock is not obvious.
In FY , the same effect was reported: Apparently, this error was finally detected, since the FY report retroactively adjusted the and average grant-date fair values to We believe executives and auditors will exert greater diligence and care in obtaining reliable estimates of the cost of stock options if these figures are included in companies income statements than they currently do for footnote disclosure. Our colleague William Sahlman in his December HBR article, Expensing Options Solves Nothing, has expressed concern that the wealth of useful information contained in the footnotes about the stock options granted would be lost if options were expensed.
But surely recognizing the cost of options in the income statement does not preclude continuing to provide a footnote that explains the underlying distribution of grants and the methodology and parameter inputs used to calculate the cost of the stock options.
Some critics of stock option expensing argue, as venture capitalist John Doerr and FedEx CEO Frederick Smith did in an April 5, , New York Times column, that if expensing were required, the impact of options would be counted twice in the earnings per share: The result would be inaccurate and misleading earnings per share.
We have several difficulties with this argument. First, option costs only enter into a GAAP-based diluted earnings-per-share calculation when the current market price exceeds the option exercise price.
Thus, fully diluted EPS numbers still ignore all the costs of options that are nearly in the money or could become in the money if the stock price increased significantly in the near term. Second, relegating the determination of the economic impact of stock option grants solely to an EPS calculation greatly distorts the measurement of reported income, would not be adjusted to reflect the economic impact of option costs.
These measures are more significant summaries of the change in economic value of a company than the prorated distribution of this income to individual shareholders revealed in the EPS measure. This becomes eminently clear when taken to its logical absurdity: Suppose companies were to compensate all their suppliersof materials, labor, energy, and purchased serviceswith stock options rather than with cash and avoid all expense recognition in their income statement.
Their income and their profitability measures would all be so grossly inflated as to be useless for analytic purposes only the EPS number would pick up any economic effect from the option grants.
Our biggest objection to this spurious claim, however, is that even a calculation of fully diluted EPS does not fully reflect the economic impact of stock option grants.
The following hypothetical example illustrates the problems, though for purposes of simplicity we will use grants of shares instead of options.
The reasoning is exactly the same for both cases. Lets say that each of our two hypothetical companies, KapCorp and MerBod, has 8, shares outstanding, no debt, and annual revenue this year of , KapCorp decides to pay its employees and suppliers 90, in cash and has no other expenses.
MerBod, however, compensates its employees and suppliers with 80, in cash and 2, shares of stock, at an average market price of 5 per share. The cost to each company is the same: But their net income and EPS numbers are very different. KapCorps net income before taxes is 10,, or 1. By contrast, MerBods reported net income which ignores the cost of the equity granted to employees and suppliers is 20,, and its EPS is 2. Of course, the two companies now have different cash balances and numbers of shares outstanding with a claim on them.
But KapCorp can eliminate that discrepancy by issuing 2, shares of stock in the market during the year at an average selling price of 5 per share. Now both companies have closing cash balances of 20, and 10, shares outstanding. Under current accounting rules, however, this transaction only exacerbates the gap between the EPS numbers.
KapCorps reported income remains 10,, since the additional 10, value gained from the sale of the shares is not reported in net income, but its EPS denominator has increased from 8, to 10, The people claiming that options expensing creates a double-counting problem are themselves creating a smoke screen to hide the income-distorting effects of stock option grants.
Indeed, if we say that the fully diluted EPS figure is the right way to disclose the impact of share options, then we should immediately change the current accounting rules for situations when companies issue common stock, convertible preferred stock, or convertible bonds to pay for services or assets.
At present, when these transactions occur, the cost is measured by the fair market value of the consideration involved. Why should options be treated differently Fallacy 4: Expensing Stock Options Will Hurt Young Businesses Opponents of expensing options also claim that doing so will be a hardship for entrepreneurial high-tech firms that do not have the cash to attract and retain the engineers and executives who translate entrepreneurial ideas into profitable, long-term growth.
This argument is flawed on a number of levels. For a start, the people who claim that option expensing will harm entrepreneurial incentives are often the same people who claim that current disclosure is adequate for communicating the economics of stock option grants. The two positions are clearly contradictory. If current disclosure is sufficient, then moving the cost from a footnote to the balance sheet and income statement will have no market effect. But to argue that proper costing of stock options would have a significant adverse impact on companies that make extensive use of them is to admit that the economics of stock options, as currently disclosed in footnotes, are not fully reflected in companies market prices.
More seriously, however, the claim simply ignores the fact that a lack of cash need not be a barrier to compensating executives. Rather than issuing options directly to employees, companies can always issue them to underwriters and then pay their employees out of the money received for those options. Considering that the market systematically puts a higher value on options than employees do, companies are likely to end up with more cash from the sale of externally issued options which carry with them no deadweight costs than they would by granting options to employees in lieu of higher salaries.
Even privately held companies that raise funds through angel and venture capital investors can take this approach. The same procedures used to place a value on a privately held company can be used to estimate the value of its options, enabling external investors to provide cash for options about as readily as they provide cash for stock. Jeder Mitarbeiter von Time Inc. Während wir nicht genau wissen, wie viele Mitarbeiter dies bei der Time Inc auswirken wird, ist es wahrscheinlich alle Mid-Level zu Führungskräften der obersten Ebene, d….
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