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Issue #4 - The True Economic Costs of Long-Term Incentives
The ceaseless debate over stock option expensing has neglected the most critical issue—while correct and fair accounting is important, quantifying the economic cost of stock options and other long-term incentive (LTI) vehicles will reveal their true impact.
Economic cost is an actual measurement of an LTI vehicle’s impact on a company’s cash flows—a much better measure of its health than earnings (which is simply a bookkeeping method that allows comparisons across companies). Yet when it comes to creating an LTI that will attract and retain key talent, many companies focus on accounting charges instead of the cash costs that really matter. Analyses show that while accounting costs of stock options differ based on reporting methodologies, the economic impacts are the same.
True long-term impact on share price comes from a valuation of likely future cash flows. So, it makes perfect sense to evaluate the economic impact of all LTI awards when making decisions about award allocations or program design. In the long run, the impact of option expensing on share prices will be negligible. Instead, companies should make strategic decisions about compensation based on their true costs to the business. This view requires shifting the emphasis from accounting to the effect of long-term incentive compensation on meeting a company’s business strategy—the ultimate determinate of success.
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