Stock-based compensation to employees behind PayPal's impressive numbers

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 per cent over the same period last year. Total payment volume of $106 billion was up 23 per cent, year over year.

Even better, PayPal’s favoured 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. 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 favoured 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 favoured alternative accounting.

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