[Congressional Record Volume 143, Number 92 (Thursday, June 26, 1997)]
[Senate]
[Pages S6477-S6479]
From the Congressional Record Online through the Government Publishing Office [www.gpo.gov]




                             STOCK OPTIONS

  Mr. LEVIN. Mr. President, a few minutes ago, we passed by voice vote 
amendment No. 556. It was an amendment which Senator McCain and I 
authored, and I want to spend a moment describing what that amendment 
does.
  The amendment provides that it is the sense of the Senate, based on 
findings that, ``(1) currently businesses can deduct the value of stock 
options as business expense on their income tax returns, even though 
the stock options are not treated as an expense on the books of those 
same businesses; and (2) stock options are the only form of 
compensation that is treated that way. It is the sense of the Senate 
that the Committee on Finance of the Senate should hold hearings on the 
tax treatment of stock options.''
  Mr. President, for the past several years, the Wall Street Journal 
has published a special pull-out section of the newspaper with an 
annual analysis of the compensation of top corporate executives. Last 
year's section had this headline: ``The Great Divide: CEO Pay Keeps 
Soaring--Leaving Everybody Else Further and Further Behind.''
  Business Week featured this cover story on its 47th annual pay 
survey: ``Executive Pay: It's Out of Control.''
  Both publications analyze the pay of top executives at approximately 
350 major American corporations, and their analysis shows that the pay 
of chief executive officers continues to outpace inflation, others 
workers' pay and the pay of CEO's in other countries, as well as 
company profits. According to Business Week, CEO's total average 
compensation rose 54 percent last year to over $5.5 million, which came 
on top of 1995 CEO pay increases averaging 30 percent.
  Meanwhile, the average 1996 raise for the average worker, both blue 
collar and white collar, was about 3 percent. In 1996 the average pay 
of the top executive was 209 times the pay of a factory worker. Little 
known corporate tax loopholes are fueling these increases in executive 
pay with taxpayer dollars. This loophole allows companies to deduct 
from their taxes multimillion-dollar pay expenses that never show up on 
the company books as an expense. Every other form of compensation is 
shown as an expense on company books. There is only one exception, and 
that is stock options.
  There is a link of all this to taxpayer dollars. Suppose a corporate 
executive exercises stock options to purchase company stocks and makes 
a profit of $10 million. Right now, the company employing the executive 
can claim the full $10 million as a compensation expense and deduct it 
on the company's income tax return.
  Someone might say, so what? All companies deduct pay expenses from 
their taxes. That's true. But there is an important difference here. 
Every other type of employee pay shows up on the company books as an 
expense and reduces company earnings. Stock option pay is the only kind 
of compensation that companies can claim as an expense for tax purposes 
without ever showing it as an expense on their books. That's because 
current accounting rules encourage, but do not require, companies to 
treat stock option pay as a company expense, so companies can continue 
to game the system.
  A single corporate executive exercising stock options can provide a 
company with a $10 million, $50 million, or even a $100 million expense 
which the company can deduct when reporting company earnings to Uncle 
Sam, but omit it when reporting company earnings to stockholders and 
the public. That is not right. Either stock option pay is a company 
expense or it isn't. Either this expense lowers a company's earnings or 
it doesn't. Something is clearly out of whack in a tax law when a 
company can say one thing at tax time and something else to investors 
and the public, and it is a double standard which should end.
  Senator McCain and I introduced legislation in April to put an end to 
the double standard. It simply says that a company can claim stock 
option pay as

[[Page S6478]]

an expense for tax purposes to the same extent that the company treats 
that stock option pay as an expense on its books. Companies would no 
longer be able to claim that stock options cost them large amounts of 
money when claiming a tax benefit, but then turn around and claim that 
it cost them nothing when reporting them to stockholders and the 
public.
  Opponents of the legislation claim that it would tax stock options. 
That is simply not true. Companies will continue to get a tax 
deduction, not a tax increase, on the options they claim as an expense 
on their books. For the options that they don't count on their books, 
they couldn't continue to receive a tax benefit in the form of a 
deduction. The choice is theirs.
  Others argue that this amendment will hurt the average employees who 
receive stock options from the company's stock option plan. Right now, 
stock option pay is overwhelmingly executive pay. In 1994, in the most 
extensive stock option review to date which covered 6,000 publicly 
traded U.S. companies, Institutional Shareholders Services found that 
only 1 percent of the companies issued stock options to anyone other 
than management and 97 percent of the stock options issued went to 15 
or fewer individuals per company.
  Nevertheless, there are a few companies that issue stock options to 
all employees and do not disproportionately favor top executives. Our 
bill would allow those companies that provide broad-based stock option 
plans to continue to claim existing stock option tax benefits, even if 
they exclude stock option pay expenses from their books. By making this 
limited exception, we would ensure that average worker pay would not be 
affected by closing the stock option loophole. We might even encourage 
a few more companies to share stock option benefits with average 
workers.
  Still others argue that there is no way to estimate what the cost of 
stock options plans are and that we're basing a tax deduction on 
estimates. But there are a number of places in the tax code that use 
estimates to determine the amount of a deduction.
  The bottom line is that the bill that Senate McCain and I introduced 
is not intended to stop the use of stock options. It is not aimed at 
capping stock options or limiting them in any way. It would not limit 
the level of executive pay. That is an issue between the executives and 
shareholders of the company. Our bill is aimed only at those companies 
that are trying to have it both ways--claiming stock option pay as an 
expense at tax time, but not when reporting company earnings to 
shareholders and the public. It is aimed at ending a stealth tax 
benefit that is fueling the wage gap, favoring one group of companies 
over another, and feeding public cynicism about the fairness of the 
federal tax code.
  According to the Joint Committee on Taxation, closing this tax 
loophole generates $181 million over 5 years and $1.57 billion over 10 
years all of which will be dedicated to reducing the deficit.
  Mr. President, I ask unanimous consent that a letter from Warren 
Buffett, Chairman of Berkshire Hathaway, to Senator Dodd dated October 
18, 1993, be printed in the Record.
  There being no objection, the letter was ordered to be printed in the 
Record, as follows:

                                      Berkshire Hathaway Inc.,

                                      Omaha, NE, October 18, 1993.
     Hon. Christopher Dodd,
     Chairman, Securities Subcommittee, Committee on 
         Banking,Housing, and Urban Affairs, Dirksen Senate Office 
         Building, Washington, DC.
       Dear Mr. Chairman: I regret that I will not be able to 
     attend your subcommittee meeting on October 21.
       Could I have appeared there, I would have wished to make 
     certain points, which I will distill here. First among these 
     is the fact that I do not object to the intelligent use of 
     stock options. I have often voted for their issuance, both as 
     a director and as a substantial owner of the issuing 
     corporations making use of them.
       I do, however, object to the improper stock-option 
     accounting now practiced. I summarized my views on that 
     subject in the 1992 Annual Report of Berkshire Hathaway and I 
     would like to repeat those comments here:
       ``Managers thinking about accounting issues should never 
     forget one of Abraham Lincoln's favorite riddles: How many 
     legs does a dog have if you call his tail a leg? the answer: 
     Four, because calling a tail a leg does not make it a leg. It 
     behooves manager to remember that Abe's right even if an 
     auditor is willing to certify that the tail is a leg.
       ``The most egregious case of let's-not-face-up-to-reality 
     behavior by executives and accountants has occurred in the 
     world of stock options. The lack of logic is not accidental: 
     For decades much of the business world has waged war against 
     accounting rulemakers, trying to keep the costs of stock 
     options from being reflected in the profits of the 
     corporations that issue them.
       ``Typically, executives have argued that options are hard 
     to value and therefore their costs should be ignored. At 
     other times managers have said that assigning a cost to 
     options would injure small start-up businesses. Sometimes 
     they have even solemnly declared that `out-of-the-money' 
     options (those with an exercise price equal to or above the 
     current market price) have no value when they are issued.
       ``Oddly, the Council of Institutional Investors has chimed 
     in with a variation on that theme, opining that options 
     should not be viewed as a cost because they `aren't dollars 
     out of a company's coffers.' I see this line of reasoning as 
     offering exciting possibilities to American corporations for 
     instantly improving their reported profits. For example, they 
     could eliminate the cost of insurance by paying for it with 
     options. So if you're a CEO and subscribe to this `no cash-no 
     cost' theory of accounting, I'll make you an offer you can't 
     refuse: Give us a call at Berkshire and we will happily sell 
     you insurance in exchange for a bundle of long-term options 
     on your company's stock.
       ``Shareholders should understand that companies incur costs 
     when they deliver something of value to another party and not 
     just when cash changes hands. Moreover, it is both silly and 
     cynical to say that an important item of cost should not be 
     recognized simply because it can't be quantified with 
     pinpoint precision. Right now, accounting abounds with 
     imprecision. After all, no manager or auditor knows how long 
     a 747 is going to last, which means he also does not know 
     what the yearly depreciation charge for the plane should be. 
     No one knows with any certainty what a bank's annual loan 
     loss charge ought to be. And the estimates of losses that 
     property-casualty companies make are notoriously inaccurate.
       ``Does this mean that these important items of cost should 
     be ignored simply because they can't be quantified with 
     absolute accuracy? Of course not. Rather, these costs should 
     be estimated by honest and experienced people and then 
     recorded. When you get right down to it, what other item of 
     major but hard-to-precisely-calculate cost--other, that is, 
     than stock options--does the accounting profession say should 
     be ignored in the calculation of earnings?
       ``Moreover, options are just not that difficult to value. 
     Admittedly, the difficulty is increased by the fact that the 
     options given to executives are restricted in various ways. 
     These restrictions affect value. They do not, however, 
     eliminate it. In fact, since I'm in the mood for offers, I'll 
     make one to any executive who is granted a restricted option, 
     even though it may be out of the money: On the day of issue, 
     Berkshire will pay him or her a substantial sum for the right 
     to any future gains he or she realizes on the option. So if 
     you find a CEO who says his newly-issued options have little 
     or no value, tell him to try us out. In truth, we have far 
     more confidence in our ability to determine an appropriate 
     price to pay for an option than we have in our ability to 
     determine the proper depreciation rate for our corporate jet.
       ``It seems to me that the realities of stock options can be 
     summarized quite simply: If options aren't a form of 
     compensation, what are they? If compensation isn't an 
     expense, what is it? And, if expenses shouldn't go into the 
     calculation of earnings, where in the world should they go?''
       With over six months having passed since those questions 
     were posed, I have had no one heap answers upon me.
       Instead, as the debate about option accounting has gone 
     forward, ``sweep-the-costs-under-the-rug'' proponents have 
     argued fervently for disclosure--for the presentation of all 
     relevant information about options in the footnotes to the 
     financial statements, rather than in the statements 
     themselves. In that manner, they say, investors can be 
     informed about the costs of options without these costs 
     actually hurting net income and earnings per share.
       This approach, so the argument proceeds, is especially 
     needed for young companies: They will find new capital too 
     expensive if they must charge against earnings the full 
     compensation costs implicit in the value of the options they 
     issue. In effect, the people making this argument want 
     managers at those companies to tell their employees that the 
     options given them are immensely valuable while they 
     simultaneously tell the owners of the corporation that the 
     options are cost-free. This financial schizophrenia, so it is 
     argued, fosters the national interest, in that it aids 
     entrepreneurs and the start-up companies we need to 
     reinvigorate the economy.
       Let me point out the absurdities to which that line of 
     thought leads. For example, it is also in the national 
     interest that American industry spend significant sums on 
     research and development. To encourage business to increase 
     such spending, we might allow these costs, too, to be 
     recorded only in the footnotes so that they do not reduce 
     reported earnings. In other words, once you adopt the idea of 
     pursuing social goals by mandating

[[Page S6479]]

     bizarre accounting, the possibilities are endless.
       Indeed, I would argue that the ``national-interest'' theory 
     is not only misguided, but wrong. True international 
     competitiveness is achieved by reducing costs, not ignoring 
     them. Over time, capital markets will also function more 
     rationally when logical and even-handed accounting standards, 
     rather than the ``feel-good'' variety, are followed.
       Back in 1937, Benjamin Graham, the father of Security 
     Analysis and, in my opinion, the best thinker the investment 
     profession has ever had, wrote a satire on accounting. In it, 
     he described the gimmicks that companies could employ to 
     inflate reported earnings, even though economic reality 
     changed not at all. Among Graham's most hilarious 
     suggestions--because the thought seemed so far fetched--was a 
     proposition that all employees of a company be paid in 
     options. He pointed out that this arrangement would eliminate 
     all labor costs (or, more precisely, eliminate the need to 
     record them) and do wonders for the bottom line.
       Today, in the world of stock options, we have life 
     imitating satire. So far, of course, companies have largely 
     substituted option compensation for cash compensation only 
     when paying managers. But there is no reason that this 
     substitution can't spread, as corporate executives catch on 
     to the possibility of inflating earnings without actually 
     improving the economics of their businesses.
       One close-to-home example, involving Berkshire Hathaway and 
     its 20,000 employees: I would have no problem inducing each 
     of them to accept an annual grant of out-of-the-money options 
     worth $3,000 at issuance in exchange for a $2,000 reduction 
     in annual cash compensation. Were we to effect such an 
     exchange, our pre-tax earnings would improve by $40 million--
     but our shareholders would be $20 million poorer. Would 
     someone care to argue that would be in the national interest?
       Many years ago, I heard a story--undoubtedly apocryphal--
     about a state legislator who introduced a bill to change the 
     value of pi from 3.14159 to an even 3.0 so that mathematics 
     could be made less difficult for the children of his 
     constituents. If a well-intentioned Congress tries to pursue 
     social goals by mandating unsound accounting principles, it 
     will be following in the footsteps of that well-intentioned 
     legislator.
           Sincerely,
                                                Warren E. Buffett,
                                                         Chairman.

  Mr. LEVIN. Finally, Mr. President, I just want to make sure that the 
clerk has the amendment in the same form that I do. I will simply read 
this amendment, and if there is any problem, the clerk can correct me. 
It has already been adopted, but I want to double check to make sure, 
and make a parliamentary inquiry, that the amendment reads as follows:

       That it is the sense of the Senate the Committee on Finance 
     of the Senate should hold hearings on the tax treatment of 
     stock options.

  The PRESIDING OFFICER. That is subsection (b) of the amendment?
  Mr. LEVIN. That is correct.
  The Senator is correct?
  The PRESIDING OFFICER. The Senator is correct.
  Mr. LEVIN. I thank the Chair.
  Again, I thank my good friend from Rhode Island for his patience.
  Mr. CHAFEE addressed the Chair.
  The PRESIDING OFFICER. The Senator from Rhode Island.

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