Cisco Systems Becomes Part of the Stock Option Accounting Solution

13th May 200510:56 am

May 13, 2005

Today’s announcement that Cisco Systems wants to establish a new financial market for stock options derivatives is welcome news. The move promises to help restore public confidence in Silicon Valley’s battered high-tech sector. The decision is historic. It signals – at long last – a desire on the part of the company to be part of the solution on the stock options accounting issue – not part of the problem. Admittedly, Cisco has surfaced its proposal just weeks before the company would have been required, over its heated objections, to adopt another method for valuing stock options that would reduce Cisco’s reported earnings substantially more than the accounting model Cisco has proposed.

Even so, I’ve long thought that a market-mechanism would be the best way to calculate the value of stock options. The chicken-egg dilemma was the obstacle: how do you create a financial market for stock options without anything tradable? How do you create something tradable without a market where the trades can occur?

Cisco, with billions of valuable options floating around, is one of the few companies big enough to create that new market.

The decision is a watershed event for the high-tech economy. I hope the announcement will influence other corporate leaders to give up their long, losing and ultimately self-destructive fight to exclude the costs of stock option grants from the earnings their firms report. That battle has cost Silicon Valley dearly, in my estimation. Lingering doubts about the accuracy of current stock option accounting practices undermine investor confidence in our financial markets and in high tech stocks. Little wonder so much cash has been flowing into real estate. When the costs of stock options are properly accounted for, investors can be more certain that reported profits are real. There is no way to calculate how many investors have been driven away by accounting shenanigans and executive excesses which all too often were tied to the off-the-books stock option monopoly money. It’s possible at least some of those investors might stop snapping up second homes and rental properties and begin gravitating back to stocks over time as more accurate accounting of the costs of options helps rebuild investor confidence in the durability of high tech stock performance numbers.

I’ve heard some people complain that smaller firms are likely to be excluded from participating in the market-based option valuation scheme Cisco is contemplating – and that those firms will be forced to use other methods that may overstate the value and cost of options in some circumstances. That may be true over the short term. But I would not be surprised to see the new market in stock option derivatives that Cisco is talking about commoditized over time and new vehicles developed that enable more participation by smaller firms.

Either way, though, at long last Cisco has thrown in the towel. Even better, the influential Silicon Valley powerhouse now promises to lead the charge in creating a market-based mechanism to better determine the value of stock options. If the firm succeeds, Cisco will remove an accounting cloud that has hung over the high-tech sector for far too long – and replace it with the sunshine of honest accounting. That can only help Silicon Valley’s economy prosper. I hope it happens quickly. That’s why I support Cisco’s petition to the SEC to allow the development of the new market-based stock option cost accounting procedures they have proposed.

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