The Financial Accounting Standards Board (“FASB”) delivered its final statement on equity based employee compensation last month, requiring publicly traded companies to expense stock options in the first annual reporting period beginning after June 15, 2005.

As FASB notes in its release of “Frequently Asked Questions” regarding the new accounting standard, the premise behind expensing employee stock options is that if the employee went to the public market to purchase an option to buy a share of, say, Cisco Systems, or Intel, that option would cost the employee money to buy.

Under financial theory, if the market sold an option that had equivalent terms to most employee stock options (exercisable for 10 years at the current market price, subject to vesting, not transferable, not salable), the market would put a price on that combination of features and limitations, and, FASB says, when a company grants an employee a stock option, it is in effect “paying” an employee an amount equal to that hypothetical price for that hypothetical option.

As an attorney who has worked with companies from start-up to public offering and beyond, I have worked with companies to design and implement stock options programs, and as general counsel to a public company, I participated in a stock option program, and I think that the FASB premise is wrong.

Participants in stock option programs, like purchasers of shares in the public markets, are acquiring an instrument that they expect to appreciate in value, to be sold in the future at a profit.

In the case of technology companies, where the company is hoping to catch the next big wave in technological or market change, and generate a giant increase in stock price, engineers, programmers, designers and marketers typically are looking at stock options not to provide a stream of income for current consumption, but to create a store of wealth that they can tap in the future.

In other words, they are taking a job that pays the bills, but with regard to the stock options, they are investing their human capital in what they hope will be a valuable asset From the company point of view, the potential future value of the options is the tool to recruit the talent that will create the future value in the company, and the vesting requirements are used to retain that work-force.

As a result of the FASB action, companies are looking at ways to replace options with other types of recruitment and retention tools. Because of the types of estimates the FASB option expensing scheme requires companies to make in order to include stock option expense on their books, continuing stock options programs on the scale and in the way they have been conducted historically presents the prospect of too much cost, and too variable a cost, for companies to bear.

(It bears noting here that the FASB option expense item represents an estimate of the theoretical cost of an option, which would be unique from company to company, given the unique value, trading history; and prospects of all companies — at no point does a company actually pay cash out of pocket in connection with the issuance of options.)

Financial investors — the ones who already have capital to buy shares in the marketplace — lose no ground as a result of the FASB rule. Employees — the ones who have invested human capital to help innovative companies grow — are penalized.

Bruce Dravis is a partner at Downey Brand LLP operating Primarily in the firm’s Sacramento and Roseville offices, specializing in corporate, securities and business law. His column appears in The Daily Journal on the third Monday of each month.