This chapter is devoted to a discussion of stock options. The author critiques some of Buffett’s takes on options, while applauding some of his suggestions. While Janjigian doesn’t come right out and say it, it appears he is not in favour of the now required expensing of stock options.
While Buffett has made it clear that he believes options should be expensed, the author takes issue with Buffett’s logic. Because the value of options are difficult to measure at the date of grant (since they can end up being worth nothing, or being worth a whole lot more than expected), the author’s take is that expensing them is not as straight forward as it is for other uncertain expenses such as depreciation (where the cost of the purchased good is at least known).
The author believes the real problem is abuse of options. Excessive grants, re-pricings and backdating are all forms of abuse that shareholders should be looking to curtail, rather than focusing their energies on forcing option expensing. Diluted Earnings Per Share already accounts for outstanding options, so the author suggests expensing is unneccessary.
The mandatory expensing of options has lead to a drop in this form of compensation. The author seems to believe this will stifle new companies, many of which cannot afford to pay enough cash to attract top managers. Unfortunately, this argument seems rather flimsy, as it could also be taken to the next step in a claim that depreciation should not be “expensed”, since this would curtail necessary capital investments.
Although the value of options is uncertain, Buffett’s argument is that we should make a best effort to put some expected value on them, rather than have the income statement completely ignore them.