eBay's stock option accounting and financial reporting ethics

ebay financial reporting

eBay Corporation: Financial Reporting

The current market trend in the American business world shows that many businesses are making the switch to the fair market value of accounting for employee stock options. The Journal of Accounting Research defines fair market accounting as accounting for the fair value, or price, of an asset or liability based on the current market price of that asset or liability, or for similar assets and liabilities, or based on another objectively assessed "fair" value (Riedl and Serafeim, 2011, p. 1083). In understanding this concept fully, one can then assess its role within specific businesses' financial decisions -- in this case, eBay.

Ethical and Financial Considerations

Footnote disclosure is a widely-used system of financial reporting, which has brought about instances of ethical questioning in past years since its introduction within eBay's reporting protocol. The introduction of backdated accounting disclosure in the form of footnotes caused an instance of ethical dilemma within eBay in 2000. This new accounting disclosure required that companies report what earnings would have been had they been in compliance with fair value stock option expensing. Upon disclosing this old material in a new format, it was gauged that in 2000, eBay reported a "net profit of $48 million," when in reality it should have "reported a loss of almost $91 million" (Bradshaw, 2005, p.1). This brings about a massive breach in ethics in terms of reporting. In a company where employees were regarded as "key risk factors," fluctuations in stock prices into "extremely volatile" zones brought about the threat of employee departure (Bradshaw, 2005, p.2-3).

Plans of reporting were then employed to attract and motivate employees and the amount of shares reserved for these employees escalated significantly within the company at the beginning. As seen in Exhibit 5 in Bradshaw's reporting, in 1996, eBay adjusted its reserved stock shares from 5,100,000 to 30,600,000 (Bradshaw, 2005, p. 8). Had fair market accounting been employed from the get-go in terms of financial reporting, employees within eBay would have proven to be far less inclined to buy up reserved stock had they known the company was not as profitable as it had been made out to be through its reporting tactics.

Financial considerations are also crucial to eBay's financial reporting, as seen in the provided financial statements. In viewing financial statements provided in Bradshaw's review, it can be seen that as the company began to see significant expansion in the late 1990s until 2000, nearly every aspect of eBay's profitability also rose significantly. The financial reporting notes that between the years of 1998 and 2000, net revenues jumped from $86,129 to $431,424, providing gross profits of $70,035 and $335,971 respectably after accounting for the cost of net revenue (Bradshaw, 2005, p. 5).

Had the aforementioned disclosure been in effect from the beginning of eBay's operations, these accountings would likely be significantly different. With disclosure of any losses comes the likelihood for stockholders to think more carefully before placing further interest in a company. While it is likely that eBay would have still taken off in terms of popularity and financial holdings, its massive rise in such a short period of time may have been extended.

Conclusion

In viewing the aspects of this particular case within eBay, the question of whether or not CEO Meg Whitman should change accounting for eBay's stock options comes into play. Should Whitman adhere to the policies of intrinsic cost-measurement accounting or switch to fair market accounting for employee stock options? In viewing the case and other evidence, it seems that a switch to the fair market manner of accounting would prove beneficial in the long-run.

As seen in reviewing evidence and noting the shock that came from the exposure of false reporting of a $48 million profit when reports should have noted a $91 million loss, one fact is clear, and this fact is mirrored by a recent article in the CPA Journal, which states:

"Perhaps the strongest argument for a move to fair-value employee stock accounting is that historical-cost financial statements do not provide information that is relevant to investors. The fact that the market value of publicly traded firms on the New York Stock Exchange is five times their asset values serves to highlight this deficiency" (Schroeder, Shortidge and Wagoner, 2006, p. 13).

This is absolutely true in looking at eBay, as seen in the referenced case study. There is clearly a reason that so many corporations are making the switch to the fair market value of accounting for employee stock options, and it would appear beneficial for eBay if its CEO and higher-ups within the company decided to make the switch sooner rather than later.