Forum Home Page [see Broadridge note below]

 The Shareholder ForumTM`

Fair Investor Access

See related case examples of

Dell Inc.

appraisal rights for intrinsic value realization

and

Walgreen Co.

stock buyback policies

"Fair Access" Home Page

"Fair Access" Program Reference

For graphs of specific company and related industry returns, see

Returns on Corporate Capital

For graphs of specific company voting for the past 5 years, see

Shareholder Support Rankings

 

 

 

Forum distribution:

Continuing investor support of fantasy financial reporting

 

For examples of the columnist's past attention to the same issues addressed again below, including her Pulitzer Prize-winning coverage of the pre-2001 bubble, see

 

Source: The New York Times | Fair Game, August 4, 2017 column

 


Business Day

The Accounting Tack That Makes PayPal’s Numbers Look So Good


Fair Game

By GRETCHEN MORGENSON    AUG. 4, 2017


Dan Schulman, chief executive of PayPal, taking a selfie after his company’s initial public offering in July 2015. Andrew Gombert/European Pressphoto Agency

Dan Schulman, chief executive of PayPal, taking a selfie after his company’s initial public offering in July 2015. Credit Andrew Gombert/European Pressphoto Agency

Investors liked what they saw in PayPal’s second-quarter financial results, reported by the digital and mobile payments giant on July 26. Revenues grew to $3.14 billion in the quarter that ended in June, an increase of 18 percent over the same period last year. Total payment volume of $106 billion was up 23 percent, year over year.

Even better, PayPal’s favored earnings-per-share measure — which it does not calculate in accordance with generally accepted accounting principles, or GAAP — came in at 46 cents per share, 3 cents more than Wall Street analysts had expected. The company has trained investors to focus on this number, rather than on the less pretty GAAP-compliant numbers most companies are judged by. And focus they did.

Exceeding analysts’ estimates — “beating the number,” in Wall Street parlance — is crucial for any corporate leader interested in keeping his or her stock price aloft. Even the smallest earnings miss can send shares tumbling.

Examining how a company meets or beats analysts’ estimates, therefore, can be illuminating.

 

Fair Game

A column from Gretchen Morgenson examining the world of finance and its impact on investors, workers and families


Big Pharma Spends on Share Buybacks, but R&D? Not So Much

Jul 14


The Trump Effect on C.E.O. Pay

May 26


Meet the Shareholders? Not at These Shareholder Meetings Mar 31

Want Change? Shareholders Have a Tool for That

Mar 24


Your Mutual Fund Has Your Proxy, Like It or Not

SEP 23 2016


EpiPen Price Increases Could Mean More Riches for Executives Sep 1

Bloated Pay Came Before Hain Celestial’s Error AUG 19

A Simple Test to Dispel the Illusion Behind Stock Buybacks Aug 12

Investors Get Stung Twice by Executives’ Lavish Pay Package

Jul 8


How to Gauge a C.E.O.’s Value? Hint: It’s Not the Share Price

Jun 17


Fantasy Math Is Helping Companies Spin Losses Into Profits

Apr 22


BlackRock Wields Its Big Stick Like a Wet Noodle on C.E.O. Pay

APR 15


In Yahoo, Another Example of the Buyback Mirage

Mar 25


Stock Buyback Plans, Seen as Shareholder Boon, Can Backfire

MAR 11


FASB Proposes to Curb What Companies Must Disclose

Jan 2

2016


Valeant Shows the Perils of Fantasy Numbers

OCT 30

2015


Safety Suffers as Stock Options Propel Executive Pay Packages

SEP 13


Why Putting a Number to C.E.O. Pay Might Bring Change

Aug 9


Tech Companies Fly High on Fantasy Accounting

Jun 21


Stock Buybacks That Hurt Shareholders

Jun 5


Shareholders’ Votes Have Done Little to Curb Lavish Executive Pay

May 16

2015


When the Stock Price Hides Trouble

Oct 12

2013


An Unstoppable Climb in C.E.O. Pay

Jun 30 2013


When Shareholders Make Their Voices Heard

Apr 8

2012


See More »

   

PayPal’s stock has been on a tear this year, up almost 50 percent since January. At a recent $59, its shares are trading at over 40 times next year’s earnings estimates. It is clearly an investor darling, providing all the more reason to dig into its numbers.

Naturally, many factors contributed to PayPal’s second-quarter earnings. But one element stands out: the amount the company dispensed to employees in the form of stock-based compensation.

How could stock-based compensation — which is a company expense, after all — have helped PayPal’s performance in the quarter? Simple. The company does not consider stock awards a cost when calculating its favored earnings measure. So when PayPal doles out more stock compensation than it has done historically, all else being equal, its chosen non-GAAP income growth looks better.

Accounting rules have required companies to include stock-based compensation as a cost of doing business for years. That’s as it should be: Stock awards have value, after all, or employees wouldn’t accept them as pay. And that value should be run through a company’s financial statements as an expense.

Consider the practice at Facebook, a company PayPal identifies as a peer. In its most recent quarterly income statement, Facebook broke out the roughly $1 billion in costs associated with share-based compensation that it deducted from its $9.3 billion in revenues.

Back in the 1990s, technology companies argued strenuously against having to run stock compensation costs through their profit-and-loss statements. Who can blame them for wanting to make an expense disappear?

They lost that battle with the accounting rule makers. But then they took a new tack: Technology companies began providing alternative earnings calculations without such costs alongside results that were accounted for under GAAP, essentially offering two sets of numbers every quarter. The non-GAAP statements — called pro forma numbers or adjusted results — often exclude expenses like stock awards and acquisition costs. And the equity analysts who hold such sway on Wall Street seem to be fine with them.

As long as companies also showed their results under generally accepted accounting rules, the Securities and Exchange Commission let them present their favored alternative accounting.

PayPal is by no means the only company that adds back the costs of stock-based compensation to its unconventional earnings calculations. Many technology companies do, contending, as PayPal does, that their own arithmetic “provides investors a consistent basis for assessing the company’s performance and helps to facilitate comparisons across different periods.”

Still, some technology leaders are dumping the practice. In addition to Facebook, Alphabet said this year that it would no longer present results that excluded the costs of stock-based compensation.

Dave Wehner, Facebook’s chief financial officer, told investors on a May conference call that the company would report results that include share-based compensation because it’s a true cost of running the business.

Ruth Porat, chief financial officer of Alphabet, which is Google’s parent company, said the same thing on a conference call in January.

Under generally accepted accounting principles, PayPal reported operating income of $430 million in the second quarter of 2017. That was up almost 16 percent from the $371 million it produced in the same period last year.

But under PayPal’s alternative accounting, its non-GAAP operating income was $659 million in the June quarter, an increase of almost 25 percent from 2016.

So what’s to account for the added $230 million in operating income under PayPal’s preferred calculation? Most of it — $192 million — was stock-based compensation PayPal dispensed to employees in the June quarter and added back to its results as calculated under GAAP.

That was a big jump — 57 percent — from the $122 million PayPal handed out during the second quarter of 2016. And back in 2015, PayPal reported just $89 million in stock awards.

I asked PayPal why it has been ratcheting up its stock-based compensation. Amanda Miller, a PayPal spokeswoman, declined to discuss why the company was raising its stock-based pay, and the role the increase played in the company’s recent results. She provided this statement: “We pay for performance and align our compensation with how shareholders are rewarded. We believe our treatment of stock-based compensation is broadly consistent with our peer group.”

But this isn’t accurate, according to the companies PayPal lists as peers in its proxy filing. At least four of those companies — Alphabet, Facebook, Mastercard and Visa — do not exclude stock-based compensation from their earnings calculations as PayPal does.

Craig Maurer is a partner at Autonomous, an independent investment research firm in New York. He follows payments companies and rates PayPal’s stock an underperformer.

In a telephone interview, Mr. Maurer was critical of how the company accounts for stock-based pay. He said that as a percentage of PayPal’s non-GAAP operating income, stock-based compensation has risen to 29 percent this year from 17 percent in 2015.

“They are literally taking a cost out of their income statement, moving it to a different line and backing it out of results,” Mr. Maurer said in an interview. “And you can see that it’s adding significantly to their ability to meet earnings expectations. If you backed out the difference between what we were expecting on stock-based comp in the quarter versus what they reported, it was 2 cents of earnings.”

In other words, the increase in stock-based compensation made a big contribution to PayPal’s results versus what analysts had been expecting.

PayPal’s stock-based compensation practices have another noteworthy effect: They drive executive pay higher at the company. Here’s how.

The company says it has three main metrics for calculating its managers’ performance pay each year. One of those measures, its proxy shows, is non-GAAP net income. So, as PayPal awards more and more stock to its executives and employees, non-GAAP net income shows better growth. And the greater that growth, the more incentive pay the company awards to its top executives.

For PayPal insiders, at least, that’s one virtuous circle.


 

A version of this article appears in print on August 6, 2017, on Page BU1 of the New York edition with the headline: Making PayPal’s Numbers Shine.

 


© 2017 The New York Times Company

Performance and Shareholder Support

The following graphs of competitive corporate performance and of shareholder voting support for executive compensation are presented for companies reported in the article, in the order of their initial text reference.

Full-size graphs of these and other companies you may select can be generated on the Shareholder Forum's websites for Returns on Corporate Capital™  and for Shareholder Support Rankings™. Definitions of both analyses are presented below.

 


 

♦ ♦ ♦

 


 

♦ ♦ ♦

 


 

♦ ♦ ♦

 


 

♦ ♦ ♦

 


 

♦ ♦ ♦

Returns on Corporate Capital™ Returns on Corporate Capital™ (ROCC) is based on published Methodology and Specifications for calculating net income plus interest expense and income taxes, divided by its prior year's ending balance of total assets less current liabilities other than current debt, according to each company's audited statements of GAAP-defined data as reported to the SEC, without adjustment. The ROCC of each company’s industry competitors is based on the same calculations of the aggregated assets and income for all SEC-reporting companies in the relevant industry other than the subject company. The analyses are produced by The Shareholder Forum using data provided by EDGAR Online from SEC records of approximately 8,000 reporting companies.

Shareholder Support Rankings™ analyses are produced by The Shareholder Forum from research data provided by Proxy Insight, based on company SEC reports of total votes cast in advisory “Say on Pay” shareholder approvals of executive compensation.

© Copyright 2012-2017 The Shareholder Forum, Inc.

 

 

 

This Forum program is open, free of charge, to anyone concerned with investor interests in the development of marketplace standards for expanded access to information for securities valuation and shareholder voting decisions. As stated in the posted Conditions of Participation, the Forum's purpose is to provide decision-makers with access to information and a free exchange of views on the issues presented in the program's Forum Summary. Each participant is expected to make independent use of information obtained through the Forum, subject to the privacy rights of other participants.  It is a Forum rule that participants will not be identified or quoted without their explicit permission.

This Forum program was initiated to address issues and objectives defined by participants in the 2010 "E-Meetings" program relevant to broad public interests in marketplace practices, rather than investor decisions relating to only a single company. The Forum may therefore invite program support of several companies that can provide both expertise and examples of leadership relating to the issues being addressed.

Inquiries about this Forum program and requests to be included in its distribution list may be addressed to access@shareholderforum.com.

The information provided to Forum participants is intended for their private reference, and permission has not been granted for the republishing of any copyrighted material. The material presented on this web site is the responsibility of Gary Lutin, as chairman of the Shareholder Forum.

Shareholder Forum™ is a trademark owned by The Shareholder Forum, Inc., for the programs conducted since 1999 to support investor access to decision-making information. It should be noted that we have no responsibility for the services that Broadridge Financial Solutions, Inc., introduced for review in the Forum's 2010 "E-Meetings" program and has since been offering with the “Shareholder Forum” name, and we have asked Broadridge to use a different name that does not suggest our support or endorsement.