Treatment of Stock Options in the National Accounts

STD/NA(2002)25

TREATMENT OF STOCK OPTIONS IN THE NATIONAL ACCOUNTSSUMMARY OF VIEWS EXPRESSED BY THE EDG

Introduction

1. In 2001 the OECD created an electronic discussion group (EDG) concerning the treatment of stock options in the national accounts. The first papers to be loaded to the EDG database were those presented at the 2000 OECD national accounts meeting:

· Treatment of employee stock options in the U.S. national economic account, U.S. Bureau of Economic Analysis

· Share options: Finnish experiences and prospects, Statistics Finland

· Employee stock options, National Accounts - Statistics Canada

· Employee share option plans and their treatment in the national accounts, Australian Bureau of Statistics

2. Subsequently, three other papers were added to the EDG database:

· Stock options, John Verrinder, Eurostat (presented at the 2001 OECD national accounts meeting)

· Treatment of employee share options in the Korean national accounts, Economic Statistics Department of the Bank of Korea, December 2001

· Treatment of stock options in national accounts of non-European OECD member countries, Francois Lequiller, OECD, January 2002.

Summary of views

3. In the analysis below it is assumed that the views expressed in the Finnish paper have been superseded by those in the Eurostat paper.

1. Should stock options be included in compensation of employees?

4. All discussants in the EDG agree that stock options are part of employee remuneration and should be included in compensation of employees. It follows that they should be treated as an expense of business in the calculation of gross operating surplus and gross mixed income.

2. When should they be recognised (i.e. time of recording in the accounts)?

5. There are three key dates with respect to stock options.

· Grant date is the date when the business entity and the employee first enter into a contract.

· Vesting date is the date when the employee has satisfied all the performance criteria and becomes unconditionally entitled to the options.

· Exercise date is the date when an option is exercised and shares are purchased at the strike price - the price agreed at the grant date, which is usually the market price at that time.

6. There is no unanimity among the discussants on the timing of the recording of stock options. They fall into two camps. Some support the grant date (U.S. and Korea) and the rest (Australia, Eurostat and Canada) support vesting date. A further [the third option is exercise date] option is to record the value of stock options progressively over the service period between the grant date and the vesting date, as this is the period over which access to the stock options is earned by the employee.

7. There does not appear to be a strong rationale for choosing the grant date. At that time the employee has not met any of the work criteria normally stipulated by the entity, so the entity is under no obligation to issue any shares or options.Two arguments for preferring the vesting date are put by Australia and Eurostat. The first is that stock options are more in the way of a bonus than wages and therefore should be recorded when they are 'due for payment'. The second is that both the SNA and ESA prohibit the recording of a financial asset or liability whilst it is contingent unless it is tradable or can be offset on the market.

3. Valuation

8. For options that are transferable there is the possibility of using market prices. Where they are not transferable an option pricing model, such as the Black-Scholes, could be used. The Eurostat paper argues that in practice most employees exercise their share options shortly after the vesting date because they are risk averse, and pricing models which assume a more optimum strategy overstate the value of the stock option. Thus, it might be best to value non-transferable stock options as the difference between the market value at the vesting date and the strike price.

9. There appears to be agreement that any difference in value between the value recorded at the vesting date (grant date for U.S. and Korea) and that recorded at the exercise date should be regarded as a holding gain or loss by the employee.

4. Practicalities

10. It appears that most countries are including stock options in estimates of compensation of employees implicitly, and they either do not know their value or they only know their value approximately. The reason appears to be that they are using tax data to derive their annual estimates of compensation of employees, and the value of stock options is lumped in with other employee remuneration. In the case of Australia, tax data are not used to derive estimates of compensation of employees and stock options are not included the Australian estimates because they cannot be separately identified.

The future

11. Most of the papers on the EDG were written two years ago. At that time it was felt that stock options were a growing phenomenon and dealing with them correctly was a pressing issue for some, but not all, countries. The International Accounting Standards Review Board has developed draft proposals for their recognition in profit and loss reporting, consistent with treatment as employee compensation. Since then there have been major developments around the world that have created a heightened sense of urgency. There have been spectacular company collapses, most notably, but by no means exclusively, in the U.S., that have led for calls to improve the quality of company accounts. In Australia, the federal government has announced its intention to pass legislation in early 2003 compelling listed companies to report their share option expenses. Similar actions appear to be happening elsewhere. This is likely to have two outcomes. The first is that national statistical agencies will be able to get access to detailed stock option data and perhaps have the ability to make adjustments to get them onto the preferred date of recording and valuation basis as necessary. The second outcome is that share options are likely to become less popular. Already in Australia, several large businesses have decided to reduce them or abandon them all together.