Let's use this area for investment related questions. Rather than respond individually via email, given the thoughtful nature of most questions, I will post responses here so that various readers can see the responses. To ask a question simply click on the Contribute An Answer Button and submit your question which will be reponded to within 24 hours in most cases.

-- Bill Parish (bill@billparish.com), April 21, 2001

Answers

Regarding your article "Dell Financial Practices Lead to "Watered Stock"... it reads "Dell took a tax deduction for wages on its tax return for options exercised and retired in excess of $3 billion, not a dime of which is charged to the publicly disclosed earnings we see." Wasn't this same amount charged as wage expense (the difference between the exercise price and the option price on the date it was granted)? I'm trying to "assess Dell's quality of earnings", and can't substantiate this point. Any help would be GREATLY appreciated

-- ! (jdj6b@virginia.edu), April 21, 2001.

Regarding your article "Dell Financial Practices Lead to "Watered Stock"... it reads "Dell took a tax deduction for wages on its tax return for options exercised and retired in excess of $3 billion, not a dime of which is charged to the publicly disclosed earnings we see." Wasn't this same amount charged as wage expense (the difference between the exercise price and the option price on the date it was granted)? I'm trying to "assess Dell's quality of earnings", and can't substantiate this point. Any help would be GREATLY appreciated!!! Also--- regarding the "speculation on it's own stock in the options market".... do you have any idea how "EITF 00-7 will impmact this? Is it safe to say this "speculation" reduces the transparency of its f/s? Also, The investment gain that you mentioned acccounts for 20% of operating income--- was that disclosed in the Q1 00 filing? I was unable to find support for that as well.

THANK YOU SOOOO much for your help!

Jen

-- ! (jdj6b@virginia.edu), April 21, 2001.

Hello Jen. Not exactly. Options are generally granted at the current market price and there is therefore no difference to be accounted for an an expense at the time of grant. This is somewhat of a ruse used by Microsoft and others, misleading you into thinking they have been accounted for. When employees exercise, the difference between the exercise price and the market price is captured as a deduction for the company and represents ordinary income to the employees. This is permanent and fixed in stone. As a masters student in accounting, you might recognize this as a "permanent" difference between the financial and tax books. Timing differences such as depreciation ultimately reconcile. In this case, the company pockets the deduction and never charges a dime to the income statement. It is true that a pro forma footnote disclosure is made but it is done off convuluted assumptions from one of the partners of the Long Term Capital Hedge fund, Myron Scholes. Mr. Scholes won the Nobel prize in 97 for his Black Scholes option pricing model and helped almost collapse the global financial system in 98 using leveraging techniques with bonds not unlike what microsoft is doing with its stock. In both cases their was an undisclosed debt pyramid.

-- Bill Parish (bill@billparish.com), April 21, 2001.

Bill,

Thank you very much for the help! One last question- I thought these companies booked wage expenses equal to the difference between the exercise price and options price on the date the options are exercised by employees. If this is not the case, I understand the manipulation. However, if they are booking these wage expenses equal to the tax deduction... where is the manipulation of earnings?

Thank you again!

Jen

-- Jennifer Johnson (jdj6b@virginia.edu), April 21, 2001.

Hello Jen. Just returned form a delightful wedding and reception and so please edit accordingly.

The key point is that the value of the options debt changes based upon the changing stock price. Mark to market is important in any debt related obligation, including options. So how can a company not recognize these changes that occur subsequent to the date of grant? That is essentially part of the argument.

-- Bill Parish (bill@billparish.com), April 21, 2001.

In 1996/97/98?? a huge hedge-fund collapsed. Around this same time, the value of the Japanese yen rose overnight from about 150 yen/dollar to about 120 yen/dollar. Isn't it true that Microsoft was using the hedge funds to artificially devalue the yen, in order to cause IBM a lot of grief due to IBM's superior market position in Japan? Didn't Richard Thoman (IBM CFO) consistently claim yen problems as a major factor in IBM's mediocre stock performance up until that time? With the yen issue deflated after the hedge collapse, didn't Thoman leave almost immediately to become head of Xerox, having accomplished his goal of maintaining IBM's fiscal soundness during the hedge wars? Didn't IBM's stock begin to rise appreciably with the yen obstacle removed?

-- Tom Nadeau (pcassembler@mindspring.com), April 23, 2001.

Thought provoking theory Tom. Of course these markets are affected by many factors and this was most likely a coindicence. The Japanese have a whole mix of issues that affect the Yen.

-- Bill Parish (bill@billparish.com), April 24, 2001.

I saw a PBS special last night on LTCM (Long Term Capital Mgmt.) and its 1998 collapse. Apparently they were indeed using speculation on the Yen (as well as the ruble and other currencies) to "hedge" their stock bets. A Russian currency default was the key event that brought down the fund. So the resumption of normal Yen values was probably not a coincidence, although it probably did not involve a Microsoft leverage attempt.

-- Tom Nadeau (pcassembler@mindspring.com), May 02, 2001.

Hello Tom. One of the LTCM partners is Myron Scholes of the Black Scholes option pricing model, used by MSFT and others. Rather complicated but LTCM was directly related to MSFT in the sense that their is only one capital market in which various assets and asset classes, including bonds, compete for interest. My favorite quote from Scholes is the one, when asked what LTCM did, he replied " we are basically sucking nickels from all over the world." An odd business, sucking nickels.

-- Bill Parish (bill@billparish.com), May 02, 2001.

Hi, While I am in significant agreement with you on the issue of accounting for stock options, the Black-Scholes formula was a major improvement compared to the previous work in the area. It is quite separate from his involvement in the collapse of LTCM. The Black-Scholes formula provides a straightforward way to value options (for large companies, even this is not necessary as LEAPS should suffice to value ESOPs). But even this value is not currently accounted for in the accounts and gives the false impression of "free" options.

Srikant

-- Marakani Srikant (srikant-finance@srikant.org), August 18, 2001.