^{Democracy & Technology Blog} Promoting innovation through employee stock ownership

Some people think we can protect shareowners, prevent corporate malfeasance and rein in lavish compensation of corporate CEOs by requiring companies to expense the value of employee stock options. Of course, the issue is a surrogate for many of the more fundamental problems of corporate governance.
Burton Malkiel, professor of economics at Princeton, and William Baumol, professor of economics at New York University, wrote in the Wall Street Journal in April 2002 that “there is no way to measure the ‘cost’ – the value of the options at the time they are granted – with reasonable precision.” But bad policy is not a compliance problem for public companies, who can easily assign a value to the options they issue because shares of their stock are traded on public exchanges every day.
What about nonpublic companies? They’re supposed to guess. It’s a fool’s exercise that will impose compliance costs and headaches on the small start-ups who are the source of most of the nation’s innovation and entrepreneurial activity. They will be forced to pay for a formal appraisal or expert opinion — every time they award options — and live with the threat that a bureaucrat can always second-guess the results. Naturally, these companies will reduce their risk exposure by reducing their use of employee stock options, and this will chiefly affect rank-and-file employees.
Now these companies will have to prove to the Internal Revenue Service that employee stock options can never be less than fair market value. A notice of proposed rulemaking and notice of a public hearing were issued in October. Comments are due Jan. 3 and the public hearing is scheduled for Jan. 25. But in typical IRS fashion, compliance begins this month. The regulations implement the new section 409A of the Internal Revenue Code, enacted by Congress.
The Republican and Democratic innovation agendas in the House both include platforms that promote employee stock ownership. The Democratic agenda, released just last month, would “Reward risk-taking and entrepreneurship by promoting broad-based stock options for rank-and-file employees.” Last year, the House voted 312-111 for legislation “that would have ensured the continued ability of innovative companies to offer stock options to rank-and-file employees,” according the Rep. David Dreier (R-CA).
Its not just the rank-and-file employees who will pay if nothing is done. We live in an ever more competitive world. Countries like China and India are increasingly prepared to do whatever it takes to stimulate innovation within their borders. In this country, we are apparently prepared to allow well-meaning but myopic bureaucrats, wherever they reside, to devise regulations that they deem easiest for them to enforce. As a nation, we all benefit when one of these small start-ups succeeds and we will all lose if misguided and half-baked policies are allowed to suffocate the technology sector.
President Bush’s innovation agenda is silent on the issue. Its time for the Bush Administration to update its agenda and pay attention to what the bureaucrats are up to.