ECONOMY

Accounting reform may lead to fairer pricing of stock options

It may have caused a stir abroad, especially in the USA, following the disclosure of a number of accounting scandals involving well-known corporations such as Enron back in 2002 but stock-option compensation never really became a big issue here, although it should for a good reason. It was abused by a few listed companies who set the terms of stock options in such a way as to guarantee big bonuses to a small number of people at the top of the corporate ladder. The introduction of IFRS (International Financial Reporting Standards) offers hope that the majority of «abused» Greek stock option schemes will at last turn into vehicles for productivity enhancement instead of tools for net-worth enhancement. Opposition to options There is no doubt that stock option compensation is not extensively used in Greece. Nevertheless, a small but growing number of listed firms have repeatedly sought and got shareholders’ approval in the last few years for share-based payments. In some cases, the major shareholders were also among the recipients of stock options so it was not difficult to get the green light at the general shareholders meeting, overriding any objections raised by minority shareholders, usually the representatives of foreign pension funds and others. However, as the issue and its implications became more known, individual shareholders also started voicing their opposition to stock option schemes at the general shareholders meetings, to no avail. At the heart of the problem is a Greek phenomenon: Instead of using stock option compensation programs to try to align the interests of management, employees and shareholders, the vast majority of Greek firms shape the terms in such a way as to guarantee a sure capital gain to the holders of stock options. They do so by setting the terms of the call option, which give its holder the right but not the obligation to buy the underlying shares at a set price, called the exercise price, within a set period of time, at very low levels. Although there are a few exceptions, setting the exercise prices very low without any quantitative performance goals attached is the rule in Greece. Even in cases where the exercise of the options is pertinent to corporate performance, the profitability goals are set so low as to ensure their achievement. If this is not enough, some local firms have gone to greater lengths to ensure that their executives and other small groups of managers are able to cash in their options. In the case of a well-known company in the packaging business, the exercise price at which the executives could have bought the shares was set equal to the nominal value of the shares a few years ago. Asked about it, an executive at the firm defended the scheme by saying the slump in profits had deprived him and his colleagues hired earlier of bonuses promised to them at the time and the terms of the stock options aimed at making up for that. Unlike other countries where abuses of stock option compensation schemes have provoked public discussion, this has not been the case yet in Greece. The facts that a small number of firms is involved, the profits have been recovered in the last couple of years and the solid performance of their stocks have all contributed to this effect. Ignorance on the part of minority shareholders about how stock options work may also explain the lack of discussion on the topic. This is so because earnings per share (EPS) dilution has been material, declining 6.0 percent in the case of a listed company last year. Even the state, which supposedly has every interest in collecting income taxes, has showed little interest in stock options. It should be noted that there is no capital gains tax on stock transactions in Greece, which may help explain the stance of the Finance Ministry. So, if there is hope about some kind of rationalization on the subject of stock options, it comes from the introduction of IFRS. In late December, the Accounting Regulatory Committee, which acts as an adviser to the European Commission on the adoption of international accounting standards, gave a positive opinion on a Commission regulation making mandatory international financial reporting standards (IFRS 2). This practically means listed European companies, including Greek, will have to account for expenses related to stock option transactions granted to employees. This means investors will easily be able to recognize and measure the impact of expensing stock options on earnings in addition to EPS dilution. Absence of fraud Having said that, it should be noted that there have been no cases of corporate fraud related to stock option compensation schemes so far in Greece. Unlike in other countries, no Greek executive has been accused of cooking the books to report higher profits so as to drive the stock price up and cash in on his or her stock options. A cynic may even say this has not been necessary given the extraordinary low price levels at which they can buy the stocks. There is no doubt that stock option compensation can become a powerful tool for growth if structured in a way that rewards hardworking individuals, including executives. Unfortunately, this is not the case thus far in Greece for the vast majority of firms which have adopted these schemes. The introduction of IFRS provides them with an opportunity to become more responsible toward their shareholder base, especially the minority shareholders, by pricing stock options more fairly in a way that enhances productivity.