Stock Options as Tax Deferral
By Arnold Kling
Kevin Hassett thinks that stock options are used because they are a form of tax-deferred compensation.
It is sensible that the tax code encourages equity compensation. Shareholders benefit when management has a significant stake in the appreciation of a firm’s stock. But the tax code wrongly encourages reliance on options and only options. While options may be the most efficient form of compensation in some circumstances, simply granting shares of stock to executives is desirable as well. If policy makers want to fix a genuine problem, stock compensation should be treated in the same way that options are. And the rule change involved is quite simple. An executive who receives unrestricted and marketable stock shouldn’t be required to pay tax until he decides to sell it.
I continue to agree with Hall and Murphy, who argue that firms use stock options to understate employee costs. If we are correct, then changing the tax laws would have no effect on the use of stock options. Indeed the fact that firms must treat stock grants as an expense even though they do not have to treat stock option grants–even though Hassett sees stock grants and stock options as substitutable forms of compensation–demonstrates the absurdity of the accounting treatment of stock options.
For Discussion. How might stock grants differ from stock options in the incentives that they create for corporate management?