The Financial Accounting Standards Board announced a proposal to require publicly-traded companies to record as a compensation expense all forms of share-based payments to employees, including employee stock options. The value of this stock compensation would "generally be measured at fair value at the grant date."

It was among the most far-reaching steps that the private rulemaker, located in Norwalk, Conn., has made in its 30-year history. The proposal is open to public comment until June 30; if approved, would be effective for the fiscal years beginning after Dec. 15, 2004.

Companies currently don't have to record the cost of options as an expense on their income statements, though an increasing number have begun to do so voluntarily. Instead, they must include the potential cost in a footnote, making it difficult for investors to gauge their effect on earnings.

"The proposal seeks to improve existing accounting rules and provides more complete, higher quality information for investors," FASB said in a statement announcing the draft.

Opponents say the change will stifle future innovation in the United States by making it more difficult for young companies to issue stock options -- a compensation tool widely used to attract talented workers without draining the payroll.

The new rule eventually will push high-tech startups to other countries, such as China and India, that don't require stock options to be expensed, said Mark Heeson, president of the National Venture Capital Association, a trade group that helped lead the fight against expensing.

"We are extremely disappointed," Heeson said. "We feel like [this recommendation] totally disregards everything we have said."

Stock options are blamed by some for aiding the corporate abuses of recent years, by enticing executives at companies like Enron and WorldCom to manipulate earnings to boost the stock price and then sell their lucrative personal holdings.

A decade ago, the FASB's attempt to push through a similar change was blocked by lawmakers. Now opponents of mandatory expensing of options -- especially high-tech companies that donate heavily to both political parties -- are staging an all-out effort legislative and lobbying effort to head off the move.

Bipartisan legislation gaining strength in the House would limit required expensing of options to those owned by the top five executives in a corporation. It would also prevent a new FASB mandate from taking effect until an economic impact study was done.

Stock options remain a popular compensation tool that many companies, namely those in the technology business as well as at startup firms, use as way to motivate employees. They allow employees to buy shares at a fixed price and then sell them at a profit if the company's stock rises.

Critics of expensing have charged that the models used to value the cost of the options are far from precise, are largely based on estimates about what the future holds and would fill financial statements with inaccurate information. They also contend expensing options would stifle economic growth.

While the FASB in its proposal did not specifically set forth a method that it wants companies to follow, it did state that its board prefers the use of a "lattice" model that takes into account the changes in the stock price over the term of the option.

The FASB also acknowledged that there may be circumstances in which companies can't reasonably estimate the fair value of their options.

For that reason, the International Employee Stock Options Coalition blasted the proposal, saying it would "significantly distort companies' financial statements, making it impossible for investors to compare the financial picture of companies and penalizing rank-and-file workers" as companies phase out options to avoid distortion of their balance sheets and investor confusion.

"More than nine years after first proposing stock option expensing, FASB still has not come up with an accurate and reliable way of doing so," said Rick White, IESOC chairman.

J. Edward Ketz, an accounting professor at the Smeal College of Business at Penn State, said that while option valuation methods have their faults, they at least force companies to disclose that options have some cost.

"The errors in the valuation methods are much smaller than pretending the cost of options is zero," said Ketz, author of Hidden Financial Risk, which explores the causes of the recent accounting scandals. "This puts us much closer to the truth than we are now."

-- Marcy Gordon, AP Business Writer

See also: Options: Old Question, New Answer