COLUMBIA BUSINESS SCHOOL RESEARCH CENTER DEVELOPS METHOD TO STANDARDIZE ACCOUNTING FOR EMPLOYEE STOCK OPTIONS AND STOCK-RELATED CLAIMS
SVA Method Addresses Concerns of Executives, Shareholders and Accounting Regulators
March 14, 2005
New York, NY (March 14, 2005) - Determining accurate accounting methods for employee stock options and other stock-related claims has long been a headache for companies, investors, analysts, standardsetters and regulators. Contradictory GAAP rulings that classify similar securities as both debt and equity have resulted in inconsistent company reporting over the years. In response to this issue, Columbia Business School's Center for Excellence in Accounting and Security Analysis (CEASA) has released a white paper that details how Shareholder Value Accounting (SVA) can provide the most accurate, consistent and transparent means of accounting for the spectrum of contingent equity claims.
Debt vs. Equity: Accounting for Claims Contingent on Firms' Common Stock Performance with Particular Attention to Employee Compensation Options is CEASA's inaugural white paper. Co-authored by James Ohlson of Arizona State University and Stephen Penman of Columbia Business School, the white paper provides a critically needed guide that consistently and accurately accounts for a range of performance-related claims, including: employee stock options, stock appreciation rights, put and call options, convertible debt and preferred stock, warrants and other hybrid securities.
SVA presents company executives, shareholders and the public at large with the most timely and accurate information about what a company is worth from the perspective of the shareholders. It eliminates the inconsistencies and confusion in other methods of accounting for these claims. The proposed accounting differs from current Generally Accepted Accounting Principles (GAAP) in that it revises the definition of a liability, recognizes gains and losses to shareholders from their claims, and resolves inconsistencies between similar claims that are currently classified as both debt and equity. Additionally, it provides shareholders with important, timely and transparent supplemental information.
Example 1: Borrowing with warrants
A firm issues warrants to buy 20 of its shares at $30 per share, receiving $200 for the issue. The $200 is treated as a liability to repay the effective borrowing with an issue of shares -- in contrast to GAAP where it is treated as equity. Interest is recorded over the life of the warrant at the firm's borrowing rate, as with any borrowing. A further financing cost arises on exercise of the warrants in the form of a loss from issuing shares at less than market value. If the per-share value of the shares issued is $45 and the firm received only $30, the total loss from exercise is $300 ($15 x 20), less interest recognized over the life of the warrants. The loss is recognized progressively over the life of the warrant as the warrant moves into the money (and gains are recognized if the warrants fail to move into the money). Correspondingly, the liability is continually fair-valued to provide timely indication of the obligation of shareholders to issue shares at a price different from market value. A similar tr eatment applies to put options, convertible bonds and convertible preferred stock.
Example 2: Employee stock options
These are treated similarly to the warrants in Example 1, to which they are similar in substance. At grant date, a liability is recognized -- rather than equity in the accounting required in 2005 by the FASB -- to reflect the contingent obligation to issue shares. Like the FASB accounting, compensation expense is also recognized. However, in contrast to the FASB accounting, subsequent gains and losses are also recognized as the option moves away from or into the money, with a final settling up to the loss incurred, on exercise, from issuing shares at less than market price (or to the gain should the option lapse). Accordingly, the full cost, to shareholders, of issuing options is recorded.
"This paper demonstrates the power of academia to provide tools for practitioners that improve the way we do business," said R. Glenn Hubbard, dean of Columbia Business School. "CEASA's strength is in bringing together faculty and end users to produce viable solutions for problems that businesses face today."
The Center for Excellence in Accounting and Security Analysis
CEASA was formed in 2003 to provide an independent, objective voice for practical solutions in financial reporting and analysis. Columbia Business School's long history of leadership in this area through faculty research and its strong relationships with the business community made the School an ideal home for the Center, which is generously funded through grants from the GE Foundation, IBM and Morgan Stanley.
CEASA is co-directed by Stephen Penman, the George O. May Professor of Accounting at Columbia Business School, and Trevor Harris, a former Columbia Business School faculty member and a current Managing Director at Morgan Stanley. They are joined by Arthur Levitt, former chairman of the Securities and Exchange Commission, who chairs CEASA's distinguished Advisory Board.
This project is available online, in our Policy Research
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COLUMBIA BUSINESS SCHOOL LAUNCHES CENTER TO ADDRESS TOUGH ISSUES IN ACCOUNTING AND SECURITY ANALYSIS
October 13, 2003
New York, NY (October 13, 2003) - Columbia Business School announces the launch of the Center for Excellence in Accounting and Security Analysis (CEASA). CEASA's Advisory Board is led by former SEC chairman Arthur Levitt. Levitt, who is currently an adviser to the investment firm the Carlyle Group, said, "The center will bring together the best ideas in academia and practice to provide objective solutions to current and anticipated issues facing regulators and practitioners." CEASA will be codirected by Stephen Penman, the George O. May Professor of Accounting at Columbia Business School, and Trevor Harris, a former Columbia Business School faculty member and current managing director at and head of the Global Valuation and Accounting Team in Equity Research at Morgan Stanley.
CEASA's Advisory Board members include Phil Ameen, vice president and controller of GE; Mark Anson, CIO of CalPERS; John Biggs, former CEO of TIAA-CREF; Richard Carroll, assistant controller of accounting at IBM; Michael Cook, former chair of Deloitte and Touche; Lee Cooperman, chairman and CEO of Omega Advisors; Stephen Crawford, executive vice president and CFO of Morgan Stanley; Sir Howard Davies, former chair of Finacial Services Authority in the U.K.; Peter Fisher, former under secretary for domestic finance, U.S. Department of Treasury; Glenn Hubbard, former chairman of President Bush's Council of Economic Advisors and professor of Finance and Economics, Columbia Business School; Sallie Krawcheck, chairman and CEO of Smith Barney; David F. Larcker, Ernst & Young Professor of Accounting, the Wharton School, UPenn; Carol Junge Loomis, editor-at-large, Fortune Magazine; James A. Ohlson, Leonard N. Stern Professor of Business and acting chair of the Accounting Department, Stern School of Business, NYU; and Robert J. Swieringa, dean of the S. C. Johnson Graduate School of Management, Cornell University, and former member of the FASB.
The first meeting of the advisory board took place on Wednesday, October 8, 2003. At the inaugural meeting, the board selected specific topics to be analyzed by unbiased expert teams. White papers will be issued and presented to regulators responsible for the formation and implementation of public policy, as well as to business leaders whose companies are affected by legislative and regulatory actions.
"Columbia Business School is a natural home for the center," says the School's Dean Meyer Feldberg. "With a rich history of fundamental analysis and access to talent unparalleled in the country, the center will be a powerful voice."
Generously funded through grants from the GE Foundation, IBM and Morgan Stanley, the center is being established at a time when financial reporting and security analysis is under unprecedented scrutiny and review.
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