| Central Valley Economy Outperforms the Returns on U.S. Assets |
The California Central Valley (Redding to Bakersfield) has expanded rapidly led by changing statewide demographics, trade globalization, and a robust housing market, allowing the Valley's return on assets to exceed national returns. The graph below compares the returns on bank stocks throughout the Central Valley as a proxy for the Valley's return on assets since community banks are required to loan and invest in a specific geographic region. The CV Regional Bank Index ("CVRBI") is compared to the returns of the S&P 500 index. The S&P 500 Index is considered to be a reliable proxy for the mean return on assets throughout the U.S. economy.
The CVRBI includes well-established community banks located in Chico, Sacramento, Stockton, Fresno, Visalia, and Bakersfield, which account for over 85% of the Valley's regional economic product. The returns on the CVRBI strongly outperformed the S&P 500 throughout 2006 but underperformed for the first four months of 2007.
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Corporate Options Grants are Treated Differently
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In December 2004, the Financial
Accounting Standards Board (FASB) revised Statement 123 (Share-Based
Payment) in an effort to make accounting for stock options more
accurate. Several studies suggest that, applied to 2003 and 2004, this
rule would have slashed reported earnings of the Standard and Poor's
500 by 8.6 and 7.4 percent, respectively. The new rules went into
effect for reporting periods starting after 12/15/2005 for small public
companies and non-public companies.
Background
The
original FASB Statement 123 was issued in 1994. It required companies
using share-based compensation (most commonly employee stock options)
to include this compensation as an expense on the income statement and
to divulge the dilutive effect these instruments had on earnings.
However, the vagueness of the statement allowed companies to creatively
avoid recognizing any expense by pricing options at-the-money (Strike
Price = Stock Price) on the grant date.
New Standards
FASB
Statement 123 was revised in 2004 to require that all entities follow
the same standard for accounting for employee stock options. The new
methodology requires companies to recognize an expense in the amount of
the fair value of the equity instrument given at the grant date. The
expense can be capitalized over the vesting period of the instrument.
If the fair value is not readily attainable (as is often the case with
non-public entities), the company should estimate the fair value using
the industry index's historical volatility (i.e. in a Black-Scholes
equation) instead of the expected volatility of the company's shares.
Table 1: Difference in Expense Recognition
Old FSB New FSB 123
Stock Price $ 10.00 $ 10.00
Strike Price $ 10.00 $ 10.00
Number of Options 10,000 10,000
Economic Value $ - $ -
Vesting Period (yrs) 4.0 4.0
Expense $ - $ 11,225.50
Table
1 above illustrates the difference between the two methodologies of
accounting for employee stock options. In this example, employees are
granted a total of 10,000 at-the-money options that vest over 4 years.
Prior to the 2004 revision, these options were not recognized as an
expense because the statement defined the expense as the economic value
of the options to the employee ($0 because they were issued
at-the-money). This simplistic approach ignored any embedded time value
the options may have had. The new FASB 123 requires the options to be
valued using Black-Scholes or some other acceptable method. In this
case, the options would have a market value of $4.4902 per option,
leading to a total expense incurred of $44,902. Because the options
vest over 4 years, the annual expense recognized would be $11,225.50.
Conclusion
As
suggested by several studies conducted prior to the change, the new
standards are impacting corporate earnings in the 7-10% range. However,
this impact appears to be already factored into the public markets as
the broad stock market indexes continue to rise fueled by strong
economic growth and better-than-expected corporate earnings. What
remains to be seen is how the new standards affect corporate viewpoints
of non-cash employee compensation. The new standards are important for
companies to keep in mind when setting up employee stock options plans
and approving grants.
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