U.S. Federal Reserve chairman Alan Greenspan assailed the accounting of stock options at the 2002 Financial Markets Conference of the Federal Reserve Bank of Atlanta, calling for options to be treated as an expense.

Greenspan’s remarks were delivered by satellite to the conference attendees at Sea Island, Georgia. The Fed chairman noted that options are important to the venture capital industry, and the high-tech industries have argued against any changes to current practices, such as requiring them to be expensed. “They argue that the use of options is an exceptionally valuable compensation mechanism; that recognizing an expense associated with these grants would reduce the use of options, harming high-tech companies; that the effect of options on fully diluted earnings per share is already recognized; and that we cannot measure the costs of options with sufficient accuracy to justify their recognition on financial statements.”

However, Greenspan noted that the accounting of option expensing is “critically important for the accurate representation of corporate performance. And accurate accounting, in turn, is central to the functioning of free-market capitalism–the system that has brought such a high level of prosperity to our country.”

“The estimation of earnings is difficult enough without introducing biases into the calculation. I fear that the failure to expense stock option grants has introduced a significant distortion in reported earnings — and one that has grown with the increasing prevalence of this form of compensation,” said Greenspan. “To assume that option grants are not an expense is to assume that the real resources that contributed to the creation of the value of the output were free. Surely the existing shareholders who granted options to employees do not consider the potential dilution of their share in the market capitalization of their corporation as having no cost to them.”

Greenspan pointed out that current accounting rules encourage firms to expense option grants. However, only two of the S&P 500 firms reportedly chose to do so in 2000. “If expensing does indeed matter, at least some of the unsustainable euphoria that surrounded dot-com investing at its peak may have been exacerbated by questionable reported earnings.”