"The single most lucrative product Microsoft sells is its own stock. Microsoft receives almost as much cash inflow from the stock market as it does by selling goods and services... Basically, Microsoft receives cash by issuing employee stock options, after which the company then receives billions of dollars in tax deductions from the IRS for doing so. Add in the warrants it sells on its own stock, and the company made over $5 billion off the stock market [for the] fiscal year end[ing] July 1999, tax-free. For comparison, its after-tax net income was only $7.8 billion. Microsoft may not be much in the programming department, but its accountants are impressive." (Landley, Rob. "Why Microsoft's Stock Options Scare Me." The Motley Fool 17 Feb 2000)
Corporations in the United States receive a tax deduction for wages paid in stock. However, these wages are not required to be charged as an expense to the public income statement. As of 2001 the wage expense from stock at Microsoft® exceeded $22 billion for a two year period. Partly due to this, Microsoft pays no federal taxes. Yet they do not report these stock wages as an expense on their income statement. If it did it would show an interesting fact: until at least 2003, Microsoft was unprofitable. Their earnings for the same period exceeded $15 billion. Subtracting wage expenses paid in stock from their profits shows them operating at a loss. Through heavy lobbying they've been able to avoid the approval of laws to close this accounting loophole.
If all of this sounds familiar it's because it caused the demise of another large corporation called Enron. Enron was the Microsoft of the energy business. (Unlike Microsoft, Enron also created shell companies to further profit from these questionable accounting practices.)
"According to an ABC News 1/22/99 article by Michael Martinez, Microsoft's own internal auditor, a respected 30 year veteran and former partner of Deloitte and Touche, was fired in 1996 after informing management that their earnings manipulations were illegal and violations of the SEC and FASB laws. He was given the option to resign or be fired and later settled for $4 million after suing under the Federal Whistle Blowers Act." (Parish, Bill. "Microsoft Financial Pyramid." Parish & Company 17 Nov 1999)
The next question one might reasonably ask: If this is the case, then how does Microsoft stay in business and why do investors still back the company? This is a simple question with a complex answer. As we saw during "the .com bubble", if investors generally believe a company will be profitable, they will commit large sums of money to back it, bringing much capital into the business. It does not take actual profit for a public company to have substantial capital. If investors believe Microsoft will raise profit, they will continue to invest. While "the .com bubble" was short, it proves that for a duration of time investors will believe what they want to believe. It's hard to believe that a 25 year old software giant is unprofitable, but as of 2003 it's a mathematical fact. So why don't we see the mainstream media reporting this as they did Enron? It would cause a huge financial disruption. Why ruin a good thing? Investors will continue to make money from Microsoft if they all continue to believe it's a good bet. Until the general investor population sees the lack of value, the company will be able to stay afloat.
July 2003, Update: Microsoft has announced they will no longer offer stock options to their employees. They may offer stocks directly as part of compensation. They even plan on correcting some financial statements by reporting stock payments as an expense. One affect has been a drop in profit estimates as their finances are more accurately reported. Another affect will be a drop in their creation of employee millionaires.
As of July, 2004, Microsoft's dividends have been basically meaningless. They're "token" dividends meant to keep investors complacent. The unofficial rule is that a publicly traded company is to retain profits for the purpose of increasing corporate growth in the near future (e.g. new hires, purchases, etc.) and as a security reserve (e.g. to cover lawsuits). Any money which is saved just for the sake of saving is supposed to be given to investors as dividends. That's the purpose of dividends: to share profit. Microsoft witheld profits from investors for over a decade and their dividends today barely touch the $50 billion they have saved up.
It's common knowledge that public companies have a few tricks they can use to provide the public with deceptively positive financial results. This anectode was anonymously posted on the web:
I used to temp for MS from 1998-2000, I was a bus rider and the traffic was so bad from Redmond to Seattle that some employees would cruise the bus stops asking for a third person to qualify for the car pool lane. If you didn’t take the HOV lane, it would add 45 to 90 minutes to your commute.
One time I got a ride with someone from accounting. The conversation must have been started about how they posted record profits that day and he was all giddy about it. He went on about how they withhold money back in some financial quarts in order to show off record results in another. I’m sure this has become familiar with many people over the 90s that once or twice a year MS would post record profits. The sole purpose would be to drive up the price of the stock. I laughed and asked him if it were legal, he said that not only was it legal, but very common in the industry. What he was doing wasn’t any different from what other companies did during the dot com explosion.