Volume 8, Nos. 10 & 11

 
The S&P 500: Where The Options Are:  It's a perennial topic: how much are earnings overstated by the use of stock options in corporate compensation packages? Estimates pop up everywhere. Often overlooked, there's one place to get a grip on the magnitude of earnings overstatement - right in the annual report footnotes.With the issuance of Statement of Financial Accounting Standards No. 123 in 1995, the FASB did not require companies to deduct the cost of stock compensation earned by employees; brute political force won out over prudent financial reporting. All was not lost, however. The statement still required companies to report pro forma earnings information in the footnotes -"pro forma" in the sense that those earnings figures recognized stock compensation as if it was any other kind of expense. Armed with this information, analysts and investors can make assessments about the generosity with which corporate boards distribute the equity interests of a firm's owners - and also make inferences about option compensation and stock performance. What follows here is an analysis of the effects of stock compensation on the index most frequently used as a proxy for the entire market: the S&P 500.

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