Financial Update (Third Quarter 2002)


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Tough Credit Lesson

Accounting Reforms Not Enough

Payment Systems

Patriot Act Implementation

Financial Markets Conference

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Financial Markets Conference Explores Venture Capital

Venture capital played a significant role in helping to finance the technology boom of the 1990s.

Through their funding, venture capital firms contributed to the surge in technological innovation and productivity gains both in the United States and throughout the world. Now that the tech bubble has deflated, there are a host of important questions to consider related to the ongoing evolution of venture capital funding and its influence on the U.S. and international economies.

For instance, will technological innovation going forward continue at a steady pace? How will venture capital performance be measured? What infrastructure exists that makes certain regions more successful at venture capital funding than others? What are the larger implications for policymakers, including the Federal Reserve, to consider?

These questions were explored as part of the Federal Reserve Bank of Atlanta’s 2002 Financial Markets Conference, which was co-sponsored by the Leonard N. Stern School of Business at New York University. The Atlanta Fed’s annual conference, held at Sea Island, Ga., brought together academicians, venture capital financiers and policymakers. A keynote address by Federal Reserve Chairman Alan Greenspan provided insight into stock options (see sidebar), which were used by many high-tech companies to attract executives during the latter part of the 1990s.

While the conference presentations and discussions made for lively debate, the work, more importantly, provides a strong basis for continuing research and evaluation of this significant source of funding for technological innovation. To view the conference papers and a listing of the speakers, see Conferences under the News and Events heading on the Atlanta Fed’s Web site (www.frbatlanta.org). The conference papers will also be featured in the fourth quarter 2002 issue of the Atlanta Fed’s Economic Review.

GREENSPAN WEIGHS IN ON THE STOCK OPTIONS DEBATE

2002 FINANCIAL MARKETS CONFERENCE POLICY SESSION PAPERS

Corporations and the Financing of Innovation: The Corporate Venturing Experience,” Paul A. Gompers, Professor of Business Administration, Harvard Business School, Cambridge

Venture Capital and the Internet Bubble: Facts, Fundamentals, and Food for Thought,” Thomas Hellmann, Visiting Assistant Professor, University of Pennsylvania, and Assistant Professor of Strategic Management, Stanford University

Boom and Bust in the Venture Capital Industry and the Impact on Innovation,” Josh Lerner, Jacob H. Schiff Professor of Investment Banking, Harvard Business School, Cambridge

Engineering a Venture Capital Market: Strategies for Replicating the U.S. Template,” Ronald J. Gilson, Marc and Eva Stern Professor of Law and Business, Columbia Law School, New York

Stock options for executives played an important role in companies’ recruitment and retention of top management talent in the high-tech boom of the late 1990s. This type of compensation remains popular today, and few people will debate stock options’ value in this regard.

But another aspect of stock options — how they are expensed from an accounting perspective — has become a hot debate topic, particularly after Enron Corp.’s failure and the accounting revelations from other companies during the past year. It was this aspect of stock options that Federal Reserve Chairman Alan Greenspan addressed in his remarks to the Atlanta Fed’s 2002 Financial Markets Conference in May.

Stock option grants are an attractive form of compensation to corporations because, under current tax laws, the value realized from the options when they are cashed in by an executive is treated as a deductible compensation expense for the company. Herein lies the problem, according to Greenspan. “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,” he said. As a result, “The seemingly narrow accounting matter of option expensing is, in fact, critically important for the accurate representation of corporate performance.”

A better approach to granting stock options, according to Greenspan, would be to tie the value of the options not just to the company’s stock price but to some measurement of how the company is performing relative to competitors. This approach, he said, would limit business judgments that are made simply to elevate the company’s stock price.

For the complete text of Greenspan’s speech, look under Testimony and Speeches on the Federal Reserve Board’s Web site at www.federalreserve.gov.