Earnings reports of companies with employee stock option programs are
misleading investors, warns Beaverton investment adviser.

February 4, 1999

By Naomi Wiebe of the Valley Times

Beaverton, OR - U.S. Firms that issue employee stock options may be overstating their profits, collectively creating a $1 trillion "asset bubble," according to Bill Parish, of Parish and Company Portfolio Advisers in Beaverton, www.billparish.com.

Parish, who is a Registered Investment Advisor with a master's in business administration from Portland State University, said he was concerned about the effect this may have on Washington county residents.

Parish said he was especially concerned about the high tech industry, where many employers offer stock option programs to employees.

Parish said some firms' profits may be overstated due to what he called an accounting loophole.  He said the loophole allows companies to not have to fully record the expense and liability of employee stock options, but claim cash and tax deductions generated from exercised employee stock options as profits.

Parish said that employees who take stock options instead of higher salary are prepaying their own future wages.

Parish was advising a client last September about exercising employee stock options when he first became concerned about the way corporations account for the stock options.  Since then he has advised clients about his concerns regarding how employee stock options are declared, even
though he said he has lost business because of his views.

As an example, he said if Microsoft restated its net income to account for its employee stock option liability, Parish said the company actually realized a net loss of $1.2 billion rather than the reported
net gain of $11.6 billion for the period of 1995 to 1998.

However, Microsoft spokesperson Caroline Boren said Microsoft does account for employee stock options on its earnings reports.  She acknowledged there had been considerable debate over how to best account for options.

"Currently, the Financial Accounting Standards Board requires a footnote disclosure of employee stock option liability on annual reports.  But Microsoft goes above and beyond FASB requirements by adding the disclosure to quarterly statements, as well," said Boren.

She said Microsoft goes the extra mile to inform its investors by providing diluted share earnings and a vesting schedule for employee stock options in a footnote to its shareholders.

In contrast to Parish's concern about Microsoft, a November 1997 New York Times article by Floyd Norris reported Microsoft does give fair warning of employee option liability.  It stated that stock profitability fell from $2.65 a share to $2.05 for that year when the stock option liability was taken into account.

While some investors may be satisfied with that, Bill Parish is not.  He wants the Financial Accounting Standards Board, which was established in 1973 to oversee U.S. accounting practices, to require companies to record option related expense on income statements.

He also thinks the math formulas companies use to figure their employee stock option liability aren't accurate.

"Take Microsoft," he said.  "Employees have been granted 450 million shares (half of which can now be exercised).  For every one dollar increase in the stock price, the liability increases by $450 million."

"If you take the stock price of $160 less the average exercise price of $24, and multiply it by the number of shares, 225 million of which can now be exercised, you get the total liability of $61 billion.  That's simple economics."

Parish wants the liability to be recognized on the financial books and said for that to happen, the accounting standards board must tighten accounting guidelines.

Parish has been told his opinions are "extreme."  But he doesn't back down.  He said that if the accounting guidelines are revised and companies are forced to record employee stock option compensation expenses on their income statements, the U.S. economy would be better off in the long run, even if a correction would occur on Wall Street.

"With reform, we may create the foundation for a new business cycle even stronger than the last," he said.

"We're fortunate here in the United States to be able to invest in so many great companies, but truth in labeling is important.  Investors can't properly compare companies' earnings without it," he said.

Parish admitted he hasn't yet been as successful as he'd like in achieving accounting reform, but he hasn't given up.  Parish said he urged the President of the Federal Reserve Bank in San Francisco, Robert Parry, to investigate the consequences of current accounting policies.  But Carol Eckert, media relations manager for the bank, said accounting policies are not in the bank's purview.

Parish also sent a report of his concerns and calculations to the Securities and Exchange Commission, the federal agency which created the FASB.  However, SEC spokesperson Duncan King said the commission's policies do not allow it to discuss the matter.