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Testimony before the Energy and Commerce Subcommittee on Commerce, Trade and Consumer Protection, regarding Stock Options and the Financial Accounting Standards Boards (FASB) proposal to mandate stock option expensing.
Chairman Stearns, Ranking Member Schakowsky, Members of the Subcommittee:
Thank you for the opportunity to appear before you today at this important hearing.
I am Steven C. Mayer, Executive Vice President and Chief Financial Officer of Human Genome Sciences. I am a member of the Small Business Advisory Committee to the FASB and participated in the first meeting of that committee on May 11, 2004. I have been a participant in the biotechnology industry for more than 20 years and have served as Chief Financial Officer of a number of biotechnology companies, both start up and public for 19 years.
I am pleased to appear today on behalf of BIO, the Biotechnology Industry Organization which represents more than 1,000 biotechnology companies and related organizations. Most of these companies are engaged in the search for therapies to prevent, treat and cure serious diseases, including cancer, cardiovascular disease, autoimmune disease, infectious diseases such as HIV/Aids and many other conditions. At Human Genome Sciences we were a pioneer in the discovery of human genes and the application of those discoveries to human therapeutics. We are currently testing in human clinical studies breakthrough treatments for cancer, lupus, rheumatoid arthritis, hepatitis C infection and even the potential bioterror threat, anthrax. In addition, we are in preclinical development of treatments for HIV infection and diabetes.
In all of my experience in the biotechnology industry, in every company with which I have been associated, and in virtually every company with which I am familiar, stock options have played a key roll in the recruitment, retention and reward of the scientists, physicians, professionals and staff. In fact, all of these companies use broad based plans that generally extend to most if not each and every employee in the company. All of our employees at Human Genome Sciences are eligible for our stock option program. So, I have a pretty good understanding of how stock options have been used in our industry, and an appreciation of the fact that stock options have been a key ingredient making the US biotechnology industry the world leader by a very wide margin.
That is why I am here today to speak on behalf of BIO, in support of the legislation that you are considering, HR 3574, and to explain why I believe there are fundamental and fatal flaws in the Exposure Draft prepared by the FASB that would require mandatory expensing of stock options.
First, I believe mandatory expensing is bad policy that will diminish the entrepreneurial spirit of our industry, reduce the availability of capital, and decrease the alignment of interests among employees, management and stockholders. Such a change will, in all likelihood, have a detrimental impact on a broad range of rank and file employees who today have an opportunity to accumulate wealth through participation in the value they help create.
Second, and most important, I believe expensing is bad accounting that will cause financial statements to become less reliable, less transparent, less comparable, more volatile, less understandable and less useful.
- Employee stock options do not represent an expense as defined in the FASB's own Conceptual Framework (CON 6). The FASB definition of expenses states that "Expenses represent actual or expected cash outflows that have occurred or will eventuate as a result of the entity's ongoing major operations". The grant, exercise or sale of shares from a stock option never, under any circumstances, result in a cash outflow.
- Expensing stock options will actually distort earnings per share by double counting the impact of the option - first as an expense, and then a second time as dilution. The true economic impact of issuing stock options is already fully captured in the dilution of earnings per share. It is actually the stockholders who give up a share of their interest in the company in exchange for value created, not the company that incurs an expense.
- Transparency means that one can understand where the numbers came from and how they were derived. Few people I know understand the Black-Scholes model, including many of those who use it. No one I know understands the lattice model, nor do they understand how they will come up with the many estimates required to implement it. This single number is only a theoretical estimate of a cost that is never actually incurred, that never results in a cash outflow and that may, in our industry, overwhelm every other category of expense in the income statement. That is not transparency. What we have today with extensive footnote disclosure - already required by the Securities and Exchange Commission - is much more transparent. This information is readily available to the investor or creditor who wishes to use it.
- Increasing the complexity of financial statements in this way will only make the information less accessible to the average investor, the small creditor, or the independent analyst. The large institutions will have the legions of analysts needed to untangle and interpret these complex statements resulting in a less level playing field than we have today.
And third, the cost of implementation and the difficulties of auditing the many estimates that would be required to implement the expensing of stock options have been severely underestimated by the FASB and will far exceed any benefit that could possibly be derived from taking the extensive information already available in the footnotes to financial statements and embedding it in the income statement as a single theoretical estimate. Implementation of this new standard will be a crushing burden to many companies in our industry.
My grave concern is that the forces that are defining this new accounting approach are driven by a desire to reshape executive compensation and not by the goal of improving financial reporting. In this setting, I am hopeful that congress will act to preserve reporting standards that result in clear, reliable, comparable financial statements.
Thank you again for this opportunity to appear before you. I would be happy to answer any questions you may have.
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