It is the shareholder who ultimately makes the sacrifice when a company issues stock options at a discount, although its cost is directly borne by the company, whether reflected in the accounts or not, experts maintain.

Meanwhile in the US, where the tradition is to give ESOPs at fair market value, there is animated debate on whether the future value of the scrip should be determined as the compensation cost of employee stock option.

Take for instance, the share is given to an employee at Rs 100. In, say, the next two-three years, the market price of the share touches Rs 1,000. Now, the debate is whether the difference should be reflected in the profit and loss account.

The argument in favour is that the employee's gain is the loss which the company (and ultimately the shareholders) suffers and should be recognised as such in the accounts.

The argument against the move is that ESOPs are given to retain talent who will increase profits of the company and hence increase shareholder value.

Besides, if the value of ESOPs go down, will there be a reverse entry in the P&L accounts?

Experts say there are sophisticated models being devised to calculate this impact of ESOPs in the P&L account. Interestingly, if these models are implemented, then profits of most of the top-rung IT companies will be completely eroded, accounting professionals maintain.

According to UR Bhat, chief investment officer and director of Jardine Fleming India Asset Management, the value of ESOPs of eight leading IT companies is 173.10 per cent of its 2000-01 estimated aggregate profits, two per cent of the aggregate market capitalisation and 4.5 per cent of aggregate equity. "Where is the balance and does it create shareholder value?" he queries.

SEBI guidelines on ESOPs dated June 24, 1999, under Schedule II (Clause 19.2) have mandated that the accounting value of the option shall be treated as another form of employee compensation in the company's financial statements. However, this is applicable only to listed companies where ESOPs were approved by shareholders after June 24, 1999, Sebi sources clarified.

It follows that any bonus, compensation or rewards in the form of stock option given by any company prior to June 1999 would be reflected in its share capital and share premium account (not as another form of employee compensation in the P&L account) and hence expenses of such companies would be understated to the extent of the discount element in the total market value of the options issued.

Therefore, companies like Infosys which had given stock options prior to June 25, 1999, are not required to show its real profits which are less than its profits disclosed. Says a top official with I-Sec: "The profits of these companies that we see today are actually inflated."

The real profit of Infosys for 1999 is Rs 65.67 crore instead of Rs 135.26 crore and for 2000 the profit is Rs 271.34 crores instead of Rs 293.51 crores had the stock compensation costs been determined as per Sebi guidelines, the company's annual report for 1999-2000 reveals.

These profit figures are arrived at by debiting the difference of the market price of the shares and the exercise price to the P&L account of the company for the company's 1994 stock option plan. The excess of the market price of the underlying equity shares as on the date of the grant of the options over the exercise price of the options, including up-front payments, if any is recognised and amortised on a straight-line basis over the vesting period of the options.

There are a number of companies which had issued options prior to the Sebi guidelines and to what extent their profits are inflated is also not easy to assess, looking at their annual reports (ARs). Since the Sebi guidelines are mandatory only after June 25, 1999, the disclosure in the annual reports of companies on accounting treatment and details of ESOPs are not adequate.

Interestingly, Infosys seems to be one of the few companies to have given detailed information about treatment of ESOPs in its AR.

Looking at the AR of Satyam Infoway it is not clear whether the stock options were given prior to June 30, 1999. It says that in fiscal 1999 the company established the ESOP which provides for issuance of 825,000 warrants to eligible employees. The warrants were issued to a welfare trust at Re 1 each on September 28.