[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
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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
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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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