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New rules on how US companies account for stock options are set to cause widespread confusion on Wall Street early next year as investors struggle to make sense of the numbers, according to investment analysts.
That will increase the number of investors who simply ignore the new numbers. Some warn it could eventually undermine the effect of the accounting change, which took more than a decade to bring about and forces companies to deduct the cost of employee options from their reported profits.
Bob Willens, an accounting analyst at Lehman Brothers, said of the change: “It’s going to be a mess.”
Rick Sherlund, software analyst at Goldman Sachs and a member of the Financial Accounting Standards Board’s user advisory council, said: “It’s going to be extremely confusing to people, at a minimum.”
The confusion is likely to hit technology companies hardest, given their extensive use of stock options to reward employees. For most US companies, which have financial years that begin in January, the rules take effect in the new year.
The predicted confusion stems from a lack of agreement on whether investors should treat option costs in the same way as other corporate expenses, as well as the difficulty many will have in understanding the transitional impact of the new rules.
Several big Wall Street banks have issued directives to their analysts requiring them to take option costs into account in their financial analyses of the companies they cover.
However, other analysts say they will instead assess companies using “pro-forma” numbers that exclude the costs. Many big investment institutions have also indicated they will disregard the formal published numbers and ignore option costs, said
First Call, whose reports of earnings forecasts are followed widely, has said it will adopt the convention that the majority of analysts who cover a particular company use – raising the possibility that estimates for some companies will have stock options included, while those for others will exclude them.
Eventually, confusion over how options costs should be regarded could lead Wall Street to abandon use of the new numbers altogether, some warn. Steve Kamman, a telecoms equipment analyst at CIBC World Markets, said: “It’s a garbage number, and garbage numbers tend to get thrown out.”