There is a case to be made for the benefits of granting options. This argument concerns the added incentive for employees to focus on improving the stock price, although standards of common sense must be applied.

This is particularly important in the cases of CEOs, most of whom are also chairmen (and, yes, they're almost all men) of their boards of directors. Not every company is lucky enough to have someone like Tom Murphy, the former head of Capital Cities / ABC, as a director. The legendary Mr. Murphy was so focused on spending money wisely that he once reportedly declined to paint the side of a building which faced a river and therefore was rarely seen.

Considering the impact an exceptional CEO can have on a company, is it penny-wise and pound-foolish to worry about the option packages floating in the rarified air of executive suites? The short answer is, no — and for three reasons. First of all, there is the issue of fairness, and the message it projects to employees. According to a study by United for a Fair Economy, "Whereas U.S. CEOs of major companies enjoyed earnings 419 times the pay of the average blue collar worker last year, the ratio in Japan was about 20 to 1..."

Second, there is the question as to the actual benefits derived from providing huge option packages to CEOs. Certainly, in the cases of two of the most successful businessmen in America — Bill Gates and Warren Buffett — extraordinary results were achieved and great wealth attained without stock options. More than that, both men took only modest salaries (by CEO standards) while building their empires -- they prospered beside their shareholders, not ahead of them.

Third, although CEO option grants usually represent a small fraction of a company's profits, it sets the pattern for the entire company. Although employees might individually receive small grants, these grants can aggregate to a meaningful percentage of reported earnings.

Viewed another way, if you owned 100% of a company which began diluting its stock by 5% annually with option grants, after twenty years, you would own only 38% of the company — without ever having sold a share! For those who would argue that twenty years is irrelevant, recognize that owning a stock is the longest term investment you can make. Bear in mind as well that most of the great fortunes in this country have been made by people who have owned a few large investments (often, just one) for a very long time.

Although a strong case can be made for granting options to employees, a better argument can be made for paying some portion of their compensation in restricted stock — in doing so, the true costs are reflected both on the company's books and in the employee's minds. With restricted stock, compensation has been paid and received, and if the share price rises over time, that compensation will increase; if, on the other hand, the price of the stock declines, both employees and public shareholders will suffer together.

There are also the issues raised when a company reprices options, lowering the exercize price to reflect a decline in the share price. The net result is that the incentive originally given to employees and executives to focus on raising the stock price is replaced by a reward for a falling stock price. Meanwhile, the shareholders who pay the bills find themselves paying additional compensation even as their stock holdings decline in value.

This unfortunate "heads I win, tails you lose" relationship between those who work for a company and those who own it is most common in the technology industry. The logic offered by executives is simple: if we don't reprice the options, we will not be able to attract and retain quality employees.

This logic has merit, but it raises a fair question: if a business can only be successful by incurring charges which, if fully reported on the income statement, would devastate earnings, what exactly is the definition of success? There is an analogy here to an occasion at Berkshire Hathaway's textile operation where Warren Buffett was told of a promising new technology to reduce costs. Rather than celebrating the possibility, Mr. Buffett noted the likelihood that the required capital expenditures would be incurred by the company but the savings would simply be competed away.

As an investor, you must consider the impact of company-stock options on earnings. By adjusting a company's reported earnings for the cost of options, you can make a more informed decision on whether or not you want to buy its stock. Just because reported earnings are overstated doesn't mean you should avoid stocks — on the contrary, stocks are an excellent investment for your future and your retirement, if your choices are well-considered, your purchases are dollar-cost averaged and your time-frame is measured in decades. Options are simply an additional cost to be factored in, raising the effective P/E ratio.

Different people can reach different conclusions regarding the right balance between the benefits and the costs of options. But on one point investors should agree: these costs are very real regardless of how we choose to account for them. As one senator remarked about expenditures in WW II, "a billion here, a billion there, and after a while it really adds up".

Suggestion: For additional information on Company-Stock Options, go to www.WealthEffect.com/Stocks/b4b10.asp and to www.fed.org/resrclib/articles/fasb_pw.html