ESOs and EPS

Current practice in the computation of earnings per share (EPS) makes it impossible to tell which of 2 companies, alike in all respects except stock options outstanding, has performed better for its stockholders. The problem is that the potential proceeds from the exercise of the options, assuming such options are dilutive, are treated as an adjustment to the numerator and/or the denominator of earnings per share. This treatment creates arithmetic problems and gives incorrect signals about firm performance for stockholder investment decisions and the appraisal of management performance. It is shown that more useful results are achieved if the presumed proceeds are related instead to the computation of book value per share.