It’s not uncommon for public companies that grant stock compensation widely to report non-GAAP earnings that back out the expense for their stock compensation programs. This is a supplement to their reported GAAP earnings (which they are required to report) of course. The practice arose after the adoption of ASC 718, before which companies rarely recognized any expense for their stock compensation programs. But, though the transition to ASC 718 has long been complete, the practice continues.
Google’s Announcement
Earlier this year, Google decided to stop backing stock compensation expense out of its earnings. Ruth Porat, Alphabet’s chief financial officer, explained the decision during an analyst conference call:
SBC [stock-based compensation] has always been an important part of how we reward our employees in a way that aligns their interests with those of all shareholders. Although it’s not a cash expense, we consider it to be a real cost of running our business because SBC is critical to our ability to attract and retain the best talent in the world. Starting with our first quarter results for 2017, we will no longer regularly exclude stock-based compensation expense from non-GAAP results. Noncash stock-based compensation will continue to be reported on our cash flow statement, but we will no longer be providing a reconciliation from GAAP to non-GAAP measures that reflects SBC and related tax benefits.
Will Other Companies Follow Suit?
A Bloomberg article urges more companies to take a similar approach (“Shame on Silicon Valley’s Stock Expense Stragglers”) and praises tech companies such as Facebook, Amazon, Google, and Electronic Arts, which are all either starting or planning to move away from excluding stock compensation expense from earnings.
Likewise, the Financial Times, calls this move a “watershed moment in Google’s financial maturity and the evolution of the Valley” (“Alphabet Opts to Spell Out Its Stock Options”). The article notes, however, that while Google’s consistent growth and profitability make this a “smooth transition,” it will be harder for other tech companies that need to back out this expense in their non-GAAP earnings to appear profitable.
And profitability is the name of the game. As noted in the Bloomberg article, many tech companies would be significantly less profitable (and some would report a loss) if they include stock compensation expense in earnings. These companies are probably pretty attached to their non-GAAP reports.
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– Barbara
Tags: non-GAAP
It looks like hope of being the next Randall Heron and Erik Lie (of the options backdating study fame) remains alive in the world of academia. Three studies relating to stock compensation have recently been published.
Non-GAAP and Street Earnings: Evidence from SFAS 123(R)
This study looks for patterns in decisions to exclude stock compensation expense from non-GAAP earnings and earnings forecasts.
Somewhat predictably, the study finds that companies exclude stock compensation expense from non-GAAP earnings when doing so presents a more positive financial picture of the company to investors (e.g., increases or smoothes earnings, or helps the company achieve earnings benchmarks). Financial analysts, however, exclude stock compensation expense from earnings forecasts when doing so helps them to better predict future earnings performance. Hmmm, now that I’ve written this, it seems hard to believe a 52-page study was needed to figure this out.
Incentives, Targeting and Firm Performance: An Analysis of Non-Executive Stock Options
In a nice counterpoint to the study “Employee Stock Options and Future Firm Performance: Evidence from Option Repricings,” that I blogged about in August (“Repricing and Company Performance,” August 31, 2010), this study finds that companies with broad-based options programs have better operating performance (based on return on assets), at least in smaller companies and in companies with higher growth opportunities per employee. The authors believe that options encourage cooperation and mutual monitoring among employees and may also serve to attract and retain higher quality employees.
Exercises of Executive Stock Options on the Vesting Date
This study looks at whether executives that exercise their stock options on the vesting date are motivated to do so by confidential information they have about the company. The study concludes that vesting date exercises are more likely motivated by the executive’s need to diversify his/her portfolio.
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– Barbara
Tags: academic studies, broad-based plans, insider trading, non-GAAP, research, Study