Late in 2004, the Financial Accounting Standards Board (FASB) issued a controversial ruling regarding how companies list outstanding options as expenses on their books. The impact of the new guidelines on public companies, which goes into effect in June, has attracted most of the attention. Private companies, however, are just as likely to feel the effects of the ruling when the guidelines go into effect for them in December.
Private firms many of whom rely on offering stock options may in fact feel the effects more profoundly because expensing options is far from a common practice among private firms. Expensing options will have at least two significant effects on private firms.
Stock in privately held companies is not publicly traded. It will be up to accountants to determine the real value of a stock option is using a mathematical pricing model. Two popular pricing models are Black-Scholes and indexing of similar publicly traded companies.
Joseph Rich, a compensation specialist with Pearl Meyers and Partners of Marlborough, MA told TheStreet.com that expensing options will reduce a firm’s reported profits overnight and could inevitably push some businesses from the black into the red. This, in turn, could frighten potential investors away. Of course, if large corporations limit their use of options, smaller firms willing to offer stock options to employees, may be able to lure brighter talents away from the larger firms.