dmschanoes at earthlink.net
Thu Jan 30 05:55:36 MST 2003
As part of the US strategy of overhauling the old Europe, Nasdaq's
vice-chairman Alfred "Bishop" Berkeley has issued a letter to the FASB
extolling the virtues of American corporate procedures as opposed to
Europe's stultifying insistence that accounting bear some tangential
relationship to actual financial circumstances. I have reproduced the
letter here for your enjoyment. Although he has never read Malthus nor
Hobbes, Berkely stated that his strategy is to create "2,3, many Global
Crossings, Worldcoms, Enrons," in Europe as a service to those who
understand that "Malthus was wrong but Hobbes was right."
"Life should be nasty, short, and brutish," said the Bishop, "for them, if
it means money for us. Let freedom ring."
The Nasdaq Stock Market
1801 K Street, NW
Washington, DC 20006
January 22, 2003
Financial Accounting Standards Board
401 Merritt 7
P.O. Box 5116
Norwalk, CT 06856-5116
Re: Public Comment on Stock Options Expensing
Something important is being lost in the current debates about stock
options. The arcane details of accounting and taxation are not the important
issues. The balance of power between managers and shareholders is not the
important issue. What is important is that America provides a way for smart,
hardworking people, entering the workforce with nothing but their wits and
their energy, to have a way to earn ownership of a significant share of the
productive assets of the economy. Broadspread ownership of our productive
assets is the surest, safest way to a rising standard of living and
For hundreds of years. people have come here for economic opportunity. At
first, it was for land. Our first "option" program was the Homestead Act,
which, like today's option programs granted ownership in return for labor
over time. A deep understanding of the relationship between ownership and a
stable society manifests itself in various programs that encourage home
ownership - from veteran's loans to the home mortgage interest tax
deduction. Don't think for a minute that these principles are limited to the
corporate world. The link between ownership and a stable society are
profound. How many times have you heard that the war in the middle east is a
result of Palestinian's desire for a "land of their own." That means "A land
that they own." There's more. There is a continuum of correlation between
stability in society and the ability of individuals to own productive
assets. Hernando DeSoto's The Mystery of Capitalism documents the
instability caused by the lack of clear title to productive assets, like
land. His insights clarify the sources of discontent, and its geopolitical
ramifications around the world. It is highly likely that behind the veneer
of religious fundamentalism is economic discontent. The inability to own and
accumulate productive assets is at the heart of the discontent that drives
able-bodied people to street protest, guerilla warfare, and terrorism.
A stable society is necessary (but not sufficient) for economic growth and a
rising standard of living. Our citizens need to own more than a house, given
our extended life expectancy and, more importantly, given the changing
demographic composition of America.
In America, stock options are the modern equivalent of the Homestead Act,
and are the only way for most American's to have a prayer of owning a
significant piece of a productive asset- the company for which they work.
Employee ownership is good for the corporation as well as the employee.
There is no better example than Herman Miller, Inc, Max Dupree, son of the
founder of Herman Miller Inc, writes about employee ownership in Leadership
Is an Art.
"Today we are one of the few public companies in the United States where 100
percent of the full-time regular employees in the U.S. who have completed
one year of service are stockholders. These two roles bring responsibilities
and rewards ....
"At Herman Miller, there is an owner and an employee in every position...
Employee stock ownership is essential to a declaration of identity.
Motivating is not a significant problem: Herman Miller employees bring that
with them by the bushel. But people need to be liberated, to be involved, to
be accountable, and to reach for their potential. We believe that more and
more working owners are winning the struggle for identity and meaning
against anonymity and frustration."
"Employee stock ownership is also clearly a competitive reality. Nothing is
being given. Ownership is earned and paid for. The heart of it is profit
sharing, and there is no sharing if there are no profits, Risk and reward
are connected logically and fairly."
"There is no smug condescension at play here. Rather, there is a certain
morality in connecting shared accountability as employees with shared
ownership. This lends a rightness and a permanence to the relationship of
each of us to our work and to each other."
In the Company of Owners, a new book by Blasi, Kruse and Bernstein,
documents increases productivity in companies with broad based option plans,
and benefits to the overall economy.
If ownership is key to a stable, productive economy, ownership is also
important to the long-term financial well being of the worker. We have
stacked the deck against labor in the United States, with low wages,
progressive taxation and deflationary effects of global competition. In a
tax system promoting consumption and penalizing savings, we compound the
difficulty of saving with forced retirement and medical advances that will
keep us alive for twenty years after we retire. Equity is the only financial
instrument that offers the possibility of growth, and is essential for
million of Americans. America helps itself by encouraging broad ownership of
Think of the alternatives. What America needs to avoid is the stultifying
lack of opportunity that characterizes Europe and much of the world. We need
broad, democratic ownership of the productive assets of the economy, not a
small financial elite controlling more and more of the economy. The battle
between the old and the new, between entrenched financial capital and
aspiring intellectual capital seems to have been already decided in Europe.
Old class attitudes probably sealed the fate of stock options in Europe.
Whatever the reason, they are rare and an awful lot of Europe's best talent
has come to the U.S. for economic opportunity. As a result, Europe has
missed leading in wave after wave of innovation, and when it has a hit, like
wireless communication, the spoils are not distributed widely.
The efforts to democratize ownership in Europe had many enemies, Underlying
class consciousness wide spread poverty after WWII, the re-emergence of
pre-war wealthy elites, and political responses to the threat of Communism
all contributed. In an effort to rebuild Europe as rapidly as possible after
WWII, American reconstituted several large banks in each country. They did
what banks are meant to do; lend money. Europe rebuilt on debt, not equity,
as a result. Europe is a debt oriented, rather than equity oriented economy.
It is estimated that fewer than 20% of European households own equities, as
opposed to 50% in the U.S.
In an effort to block Communism, labor was given a large role in corporate
governance a majority minus one on management committees in Germany, for
example. Labor's dreams and aspirations are focused on those union leaders.
Labor's power runs through them. The last thing they want is for union
members to be owners or to think like owners.
European wealthy elites, the handful of families that own the largest share
of Europe's productive assets, control as much as they can by interlocking
holdings, interlocking boards, and multiple classes of equity shares. These
legal structures are designed to limit access by newcomers. This is
financial capital ensconced at its finest. The idea of intellectual
capital - smart, hardworking, inventive and "low class" - earning
progressively larger pieces of ownership is anathema to ensconced wealth
trying to hold on to its relative social position over generations.
In the U.S., stock options are the most logical way to reward intellectual
capital, in a winwin way. The decisions are distributed widely in a large
number of corporations. Corporations are the unit of production able to both
recognize and reward talent. Competition will reward good decisions in
talent and punish bad decisions.
But many forces are lining up against stock options. First come the
accountants. Like all human endeavors, accounting has its own internal
politics and fads. A current fad is to run more and more transactions
through the income statement, and to put on the balance sheet more and more
human judgments, particularly about future values. The profession is in the
grips of its theoreticians.
At any rate, the accounting profession is in the throes of its own battle
for intellectual control, and the more arcane the accounting concept, the
more accountants have employment. From an accountant's perspective, the view
ahead looks fine. As a member of an accounting industry lobby group gushed
to me when Sarbanes-Oxley passed, "That's our language!", referring to the
requirement for "financial expertise" in corporate boards. She viewed
Sarbanes-Oxley as the Accountant's Full Employment Act of 2002. Investor's
need to understand that, while the public debate is couched in moralistic
and theoretical terms, politics underline many efforts and special interest
There is a fundamental problem if the income statement theorists prevail,
and it revolves around the fact that stock options are already accounted for
in dilution. The current argument is emotionally charged and ignores the
elegant symmetry of Piccolo's approach. This elegant, 400 year old system
already account for options, through "fully diluted" calculations. As the
manager of the Third Avenue Growth Fund says, "of course stock options are
an expense, they are an expense to shareholders, but not an expense to the
corporation". Expensing options double counts them, moves financial
statements farther from accurate representation, and makes it more, not
less, difficult for investors to understand the true condition of their
company. Double counting the impact of options will hurt everyone in the
long run because it is less accurate, less truthful.
With accountants calling for expensing of options, it makes it particularly
easy for othcrs, with other agendas, to pile on. The shareholder's rights
crowd, operating in a country where shareholders have more rights than any
where else in the world, always needs another initiative to generate
conflict and stay in the media. The shareholders rights movement has two
elements, the plaintiff's bar, a chorus of pundits and media hangers-on and
some larger institutional investors. Sarbanes-Oxley requires all stock
options to be voted on by shareholders. It is probably an appropriate shift
of power from corporate boards to shareholders. Time will tell. This balance
between what is best left to boards and what is best left to shareholders is
a delicate one. We have to wait to see if there are unintended consequences.
Managers of some large pension funds and mutual funds are actively involved
in the shareholders' rights movement. Fund managers have a legitimate seat
at the debate and are an interesting contrast to venture capitalists, who
are also fiduciaries for other's monies, and who are generally on the
opposite side of the stock option issue. Why the difference? Why the stark
Pension fund managers and mutual fund managers are essentially passive
fiduciaries. The index funds are quite passive. Even active managers are
typically passive when it comes to corporate governance. The situation is so
bad that many rely on outside services to advise them how to vote on
corporate resolutions. (This has created a separate locus of power in the
advisory services, who allegedly abuse this power in sort of an extortion
game, charging companies information about an otherwise opaque voting
process, and, allegedly, recommending votes against the resolution's of
There are literally thousands of pension and mutual fund managers. Host
under-perform the market indexes. In addition, they are graded to five
decimal points against each other in superficial, short term ways that can
make or break money flows into or out of their funds, money flows that in
turn, can make or break an individual fund manager's career. As a result,
most are extremely short term oriented, typically behaving as speculators,
not investors. They are against the dilution to their ownership that
employee options imply because they don't plan to hold the stock long enough
to see the long term improvements created by energized owner-employees
Contrast these passive, absentee fiduciaries to venture capitalists. They
too are fiduciaries, managing money for others, often the very same pension
funds discussed above. But they are not absentee and they are not passive.
They participate actively in the corporate decisions that their investees
make, holding board seats, recruiting talent, and profiting directly from
the success of the company. And they are passionate advocates of stock
What causes the different attitudes about stock options? Passive fund
managers tend to see options as a win-lose matter. The more shares optioned
away from current shareholders, the less available to current shareholders,
and the lower their almighty fully-diluted quarterly profit per share.
Active venture capitalists tend to see options as a win-win matter. The
talent attracted by options builds the company more than their options
dilute the venture capitalist's share. In other words, where passive fund
managers see a closed, static system, active venture capitalist see a open,
dynamic system. Therein lies the difference. Static, linear models are easy
to portray as "win-lose". Complex dynamic systems are hard to understand and
yet can be "win-win".
Passive fund managers either cannot see or do not give credit to management
talent for growing the business more than the dilution their options cause.
Active venture investors understand the dynamics of growth and the role of
talent. They can be patient enough to let growth compound, as they are
graded over 7-10 year cycle.
Large companies which do not grow very rapidly and which do not use options
widely, are delighted to do anything that makes stock options less
attractive, less affordable. They are sick and tired of losing able people
to venture backed competitors.
Next come the Europeans, who see options an unfair competition and need to
pull us down to their own miserable levels of opportunity and performance.
Europe has tried and failed to use options to motivate innovation and spread
Unable to unleash the creative power of their own economies, Europeans,
particularly bureaucrats, are appalled at the willingness of American
workers to accept low wages and willingly work 50 and 60 hours weeks in
return for a sliver of ownership in their own business. Using "convergcnce
of accounting standards" as a political grail, they plan to lower America to
their own pitiful level of innovation and labor mobility.
There is a certain dog-in-the-manger quality to our own press's approach to
these issues. Most reporter's are wage-slaves to mature, consolidated media
empires. These smart, ambitious knowledge workers stand almost no chance of
earning a lot of money, and even less of earning ownership in the newspapers
or magazines they work for. Smart as can be, and oh-so-human, it is easy for
them to lash out at stock option schemes that they cannot have. Furthermore
the media's current fad is to depend on conflict, and character
assassination. It is so easy to condemn stock options as greed on the part
of a few managers. At the same time, there is very little conflict in or
drama in the slowly accumulating wealth of million of workers receiving
broad based options, and hence few reasons for media focus.
The fact that a handful of allegedly crooked CEO's made more than they
should have out of options, compounds the confusion and muddies the
argument. The heart of this debate is about board based ownership of
options, not the abuses of a concentrated elite. There are ways to
discourage abuse at the top and encourage broad option grants.
Another knot in the stock option debate involves the fact that it is
relatively easy to quantify the "costs" of options (laying aside the
absurdity of applying short term option pricing models to illiquid long term
options) and difficult to qualify the "benefits" of the driven, focused
creativity an option holder creates. In a nation fascinated with numbers and
an attention span unable to comprehend either complex dynamic systems or
compounded benefits over time, we may embrace a short term seemingly
precise, wrong answer rather than the ambiguities and uncertainties of a
more promising, long term, dynamic system.
A third knot in the debate is our instinctive isolationism. We have already
begun to see talent and corporations seek opportunity elsewhere. One major
technology company, Novellus, lost its chief technology officer, a brilliant
fellow, to a start-up in China. The inducements included, guess what, stock
options at pennies per share and no taxes on those options. The exodus of
major corporations to Bermuda to find a fairer international tax environment
is related in that it reflects our attitudes, attitudes that presume we are
more competitive than we really are, that we are somewhat isolated from the
international competition. We are not.
A fourth knot in the current discussion involves the illogical reference
points built into current accounting policy and tax law. Years ago, as a way
to encourage companies to grant options, not as a matter of accounting or
tax theory, companies were allowed to deduct the value of shares issued to
workers. This tax goodie set a precedent that still confuses almost
everyone. There was no accounting justification for this deduction, and it
should be recognized for what it is, an incentive, or abolished. More on
Additionally, we give favorable tax treatment of options that vest in the
basis of service over time, but of tax options that vest based on
performance goals achieved. All share transactions should be treated for tax
purposes as purchases and sales by employees. Options granted at or above
market, and earned through performance, should be taxed when the employee
sells the shares. The time value of the options should not be taxed, but
should be the nation's encouragement to issue options to employees - a
modern Homestead Act.
A formidable array of special interests does not mean that these special
interest agenda's are right, or that the opportunity to encourage broad
ownership of equity shares through options is lost. The simple truth is that
America helps itself most by encouraging ways for newcomers to earn a piece
of the American dream. Stock ownership in the productive assets of our
economy is essential if all these new faces - brown, black, yellow, white -
are to find a stable place in our economy as they become adults and enter
the workforce. This economic pie needs to get a lot bigger if we are going
to accommodate all those wonderful, smart, hardworking dreamers. Stock
options, widely distributed, Federally encouraged, are the best way to grow
our economy and are the logical successor to the Homestead Act that served
us so well in the past.
Alfred R Berkeley
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