"Preserving Partnership Capitalism Through Stock Options for America's Workforce"

May 8, 2003

Statement of Mr. James Haddad

Chairman, Financial Accounting and Investor Relations Task Force

Association for Financial Professionals

Thank you Senators Enzi, Lieberman, Allen, and Boxer for the opportunity to participate in today's roundtable discussion. The public debate over the expensing of stock options is important, as many believe that the outcome will impact the pace of innovation in America and over time, the U.S. economy.

I am James Haddad, vice president of corporate finance for Cadence Design Systems which is an electronic design automation software company located in the heart of Silicon Valley, San Jose, in the great state of California. I am here in my role as Chairman of the Association for Financial Professionals' (AFP) Financial Accounting and Investor Relations Task Force. AFP represents over 14,000 treasury and corporate finance professionals employed by over 5,000 corporations and other businesses.  AFP members represent a broad spectrum of financial disciplines and their organizations are drawn generally from the Fortune 1000 and middle-market companies in a wide variety of industries.

AFP opposes any requirement that companies record as an expense the fair value of stock options issued to employees. AFP does not believe that employee stock options represent a true cost to the corporation when granted.  While AFP acknowledges that employee stock options have value to employees, we believe that the cost is borne by shareholders, not the company. When stock options are granted to employees, the cost is best reflected through dilution of the shareholders participation in the company's earnings. Accordingly, AFP strongly believes that the cost of stock options is most accurately reflected in fully diluted earnings-per-share, which is a required disclosure under current accounting rules.

AFP believes that there is no currently acceptable model that accurately values the cost of employee stock options. It is well-known that there are significant measurement limitations associated with the model most widely used, the Black-Scholes option-pricing model. The Black-Scholes model, which is cited by the Financial Accounting Standards Board as an acceptable method, was developed for estimating the costs of marketable options. Marketable options have defined expiration dates and are usually held for relatively short time periods. Employee stock options do not generally share those characteristics. Employee stock options normally cannot be sold by the employee and are not available to employees until a vesting period has elapsed. After vesting, employees usually have a long time period before the options expire.  In addition, under most circumstances, employee stock options are forfeited when an employee leaves the company.

The unique features of employee stock options generally expose the employee to additional risk when compared to marketable options.  This in turn lowers the value of the stock options. Because Black-Sholes does not consider such risks, using it consistently overstates the value of employee stock options. Such an overstatement will then be reflected in financial statements that that do not accurately portray the financial position and results of operation of a company. If the accounting standard setters require the expensing of employee stock options, AFP believes that it is imperative that they conduct additional research to identify modifications that address the shortcomings of Black-Scholes.

We also do not see how expensing stock options enhances the information value, or the transparency, of a company's financial statements. Cash flows are a critical component in valuing a company. Investors use cash flow to determine a company's ability to provide a return of capital in the form of a dividend or through share repurchase. Since stock options expense is a non-cash charge, it is likely that investors will subtract the cost from reported expenses in order to gain a better understanding of the company's ability to generate cash earnings.

While no one can predict with certainty the economic impact of expensing stock options, there are some compelling study results. A Rutgers University study found that productivity improved after companies granted options to rank-and-file employees. Yet a recent survey by Buck Consultants revealed that over half of the 117 surveyed companies would not grant options to most employees if they had to be expensed.  This is significant in light of an American Electronics Association assessment, where they found that 84% of employees received stock options in the technology sector over the last three years and that non-officers received 66% of the value of options. At Cadence Design Systems, for example, all employees are eligible for stock options.

The innovation that helped fuel many technological advances was arguably in part spurred by employees who had an opportunity to share in ownership benefits through stock options. Given the sharp declines in the technology sector and the sub-optimal performance of the U.S. economy, one must question if it is appropriate to risk impairing such an important productivity tool without an assessment of the impact on the economy and on innovation.

Thank you for the opportunity to participate today, and I am happy to answer any questions that you might have.