I almost missed a rather large news item today: Microsoft is going to stop granting its employees stock options and instead begin giving them actual stock. As a result, the company will also expense these stock grants against their income, drastically cutting their profit on paper. If you're not aware, companies that give employees stock options generally don't subtract the value of those options from their income when determining expenses; a company that pays its workers partially with stock options rather than cash can eliminate huge costs from their budgets, boosting profits artificially. Essentially, using stock options to pay employees is tantamount to a giant pyramid scheme.

Bill Parish has been all over Microsoft for using this tactic, and wrote in 1999:

The fundamental problem is that Microsoft is incurring massive losses and only by accounting illusions are they able to show a profit. Specifically, Microsoft is granting excessive amounts of stock options that are allowing the company to understate its costs. You might ask yourself, what would happen to Microsoft's stock price if the public suddenly realized that they lost $10 billion in 1999 rather than earning the reported $7.8 billion? If 80 percent of its stock value or roughly $400 billion is the result of a pyramid scheme, one might also ask what kind of effect this could have on the retirement system. It is also important to note that this is a relatively new situation that did not occur before 1995. Microsoft has always been a highly valued stock and that might have been justified prior to 1995.

This situation is not about stock valuation, product quality or whether or not Microsoft has monopoly power in its markets. Nor is it part of a pro or anti-Microsoft movement. This situation is instead a shining example of financial fraud and corruption enabled by bad government policy. If not quickly and aggressively addressed, we will all be losers as credibility in our financial markets is destroyed.

Sounds kinda prescient, doesn't it? Now that Microsoft is going to (supposedly) stop these financial shenanigans -- and even pay a dividend -- what's going to become of the company? Bill Parish has claimed that Microsoft would be losing money rather than showing a profit if it wasn't paying salaries with options, but it's clear that the company's managers don't expect that to be the case now that the policy is changing.

All of this comes in the wake of President Bush's dividend tax cut, so perhaps Microsoft is on the leading edge of the new optimal equilibrium that will take shape under this tax structure.



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