The Ups and Downs of Stock Options
After a long boom period, employee stock options have come under criticism over the last year or so. The result has been an evolution in the way we think about options as well as in option plans themselves. The question is whether options are still a global wave of the future or whether their heyday is over.
The last decade was a time of tremendous growth in the number of people eligible for options: from about 1 million U.S. workers in 1990 to about 10 million today. There was a large spurt in 1999, when 19% of employees at about 1,300 surveyed firms were eligible for options, up from 7% the year before, according to consulting firm Watson Wyatt Worldwide. What's more, options have been taking off in parts of Europe. Just last month, the Wall Street Journal reported that "more and more [European] companies are adopting option plans for the first time or expanding them beyond top management to include midlevel employees."
Not only have options become more broad-based, the way in which they're granted has changed. Most grants used to be one-time affairs. The National Center for Employee Ownership (NCEO) recently studied option plans at 247 public and private companies with broad-based plans, and it found that most of these firms now offer stock options to employees on an ongoing, periodic basis. Among studied companies, an average of 81% of hourly employees are eligible for periodic/ongoing options, as are 93% of salaried nontechnical employees, 95% of salaried technical employees, 96% of middle managers, and 97% of senior managers.
Yet, despite these signs of growth, some experts have become more skeptical of stock options lately. For one thing, a study by Watson Wyatt found that even before the plunge of the NASDAQ, companies that made the biggest option grants tended to produce the lowest total returns to shareholders; they also suffered greater levels of stock price volatility, according to the New York Times. The study concludes that heavy use of stock options encouraged executives to pursue riskier business strategies.
Providing lots of employee options also tends to dilute stock, lowering earnings-per-share to stockholders. Organizations with a large percentage of unexercised options have "option overhang," and firms with the high overhang produced lower total returns to shareholders in 1998 and 1999 than did other companies. Companies with medium overhang showed a 17.8% shareholder gain in that period, compared with a 7.4% gain for those with high overhang and a 14.3% average gain for those with low overhang.
Of course, there's also the impact of declining stock on employee morale. Not only do many options become virtually worthless in a downturn, employees who have a large amount of retirement income wrapped up in company stock can get hit particularly hard. "When the stock falls, those who get laid off see their savings obliterated when they need them the most," reports Time magazine. There have also been cases of employee holders of incentive stock options getting walloped by the U.S. Alternative Minimum Tax. They're taxed according to the value of the stock when they exercise their options, even if they don't sell the stock and even if the shares eventually become worthless. In an April 6th article in Wired News, Ed Carberry, project director at the NCEO, states, "What's happened is a lot of employees exercised last year when the market was high, and the stock price fell. Now they're stuck having to pay the tax."
There are also legal dangers involved in providing options. HRfocus reports, "Growing eligibility for stock options brings increasing opportunities for lawsuits." Such lawsuits may involve anything from charges of discrimination to accusations of fraud.
Despite the potential problems, however, many employers continue to believe in options as a way to attract and retain skilled employees. Rather than give up on options during the bear market, many are reissuing them, sometimes with a twist. One novel strategy is to issue new options six months and one day after employees give up their old ones. This is intended to circumvent accounting rules that force firms to take a large hit against earnings for the cost of the repriced options. "This has become the strategy du jour for companies that want to reprice their employee stock options," reports the Wall Street Journal. "It costs the company nothing. And – unlike the alternatives of granting new options at current prices or just making stock grants to employees as some companies have done – it doesn't dilute existing shareholders."
On the other hand, this scheme represents a gamble for employees, who must decide whether to give up old options in exchange for new ones six months later. In some cases, it may also create a perverse incentive. "During that period of time, the employees' motivation is totally different than the companies' – they want the stock price to stay down," claims Linda E. Amusa, cofounder of HR consulting firm iQuantic.
Will the trend toward stock options survive economic downturns and the advent of new schemes? Corey Rosen, executive director of the NCEO, suggests that broad-based options will ultimately remain popular. He writes, "Few people accumulate much wealth on salary alone. Companies and their employees have clearly figured out that the road to wealth lies in ownership." Nonetheless, recent trends show that the road is not without its detours and hazards.
====================================================
To get a free copy of The National Center for Employee Ownership's "An Overview of How Companies Are Granting Stock Options," go to
http://www.i4cp.com/2IN04C
The home page of the NCEO is at
http://www.i4cp.com/L20LFa
To read an article on stock options and the Alternative Minimum Tax, see
http://www.i4cp.com/d9WlGL
To see Watson Wyatt's press release entitled "Technology Companies with Highest Use of Stock Options Provided Lowest Returns to Shareholders During NASDAQ Decline," see
http://www.i4cp.com/dzjrnS
Another PR on stock options and price volatility can be found at
http://www.i4cp.com/PFmTZ9
To read the Wired News article "Options: No Execs Need Apply," see
http://www.i4cp.com/yvKdPG
To read "New Economy: Lose Money, Pay Tax," see
http://www.i4cp.com/N7vxZj
To read "Options, Get Your New Options," see
http://www.i4cp.com/Wv4LDT
The Wall Street Journal's homepage is at
http://www.i4cp.com/78IdQZ.
WSJ subscribers can find various articles about employee stock options, including "When Firms 'Reprice' Options, Workers Face Difficult Choice" (June 4), "Options About Stock Options, and a Geography of the Pitfalls" (June 4), and "Europe, a Latecomer, Embraces Options Even as Market Swoons" (May 15).
For a link to the National Association of Stock Plan Professionals, see
http://www.i4cp.com/9txw4h
The Investor Responsibility Research Center, which has reports on stock dilution, can be found at
http://www.i4cp.com/DnvG6g
For a site targeted toward people with stock options, see
http://www.i4cp.com/vLYNWL
The last decade was a time of tremendous growth in the number of people eligible for options: from about 1 million U.S. workers in 1990 to about 10 million today. There was a large spurt in 1999, when 19% of employees at about 1,300 surveyed firms were eligible for options, up from 7% the year before, according to consulting firm Watson Wyatt Worldwide. What's more, options have been taking off in parts of Europe. Just last month, the Wall Street Journal reported that "more and more [European] companies are adopting option plans for the first time or expanding them beyond top management to include midlevel employees."
Not only have options become more broad-based, the way in which they're granted has changed. Most grants used to be one-time affairs. The National Center for Employee Ownership (NCEO) recently studied option plans at 247 public and private companies with broad-based plans, and it found that most of these firms now offer stock options to employees on an ongoing, periodic basis. Among studied companies, an average of 81% of hourly employees are eligible for periodic/ongoing options, as are 93% of salaried nontechnical employees, 95% of salaried technical employees, 96% of middle managers, and 97% of senior managers.
Yet, despite these signs of growth, some experts have become more skeptical of stock options lately. For one thing, a study by Watson Wyatt found that even before the plunge of the NASDAQ, companies that made the biggest option grants tended to produce the lowest total returns to shareholders; they also suffered greater levels of stock price volatility, according to the New York Times. The study concludes that heavy use of stock options encouraged executives to pursue riskier business strategies.
Providing lots of employee options also tends to dilute stock, lowering earnings-per-share to stockholders. Organizations with a large percentage of unexercised options have "option overhang," and firms with the high overhang produced lower total returns to shareholders in 1998 and 1999 than did other companies. Companies with medium overhang showed a 17.8% shareholder gain in that period, compared with a 7.4% gain for those with high overhang and a 14.3% average gain for those with low overhang.
Of course, there's also the impact of declining stock on employee morale. Not only do many options become virtually worthless in a downturn, employees who have a large amount of retirement income wrapped up in company stock can get hit particularly hard. "When the stock falls, those who get laid off see their savings obliterated when they need them the most," reports Time magazine. There have also been cases of employee holders of incentive stock options getting walloped by the U.S. Alternative Minimum Tax. They're taxed according to the value of the stock when they exercise their options, even if they don't sell the stock and even if the shares eventually become worthless. In an April 6th article in Wired News, Ed Carberry, project director at the NCEO, states, "What's happened is a lot of employees exercised last year when the market was high, and the stock price fell. Now they're stuck having to pay the tax."
There are also legal dangers involved in providing options. HRfocus reports, "Growing eligibility for stock options brings increasing opportunities for lawsuits." Such lawsuits may involve anything from charges of discrimination to accusations of fraud.
Despite the potential problems, however, many employers continue to believe in options as a way to attract and retain skilled employees. Rather than give up on options during the bear market, many are reissuing them, sometimes with a twist. One novel strategy is to issue new options six months and one day after employees give up their old ones. This is intended to circumvent accounting rules that force firms to take a large hit against earnings for the cost of the repriced options. "This has become the strategy du jour for companies that want to reprice their employee stock options," reports the Wall Street Journal. "It costs the company nothing. And – unlike the alternatives of granting new options at current prices or just making stock grants to employees as some companies have done – it doesn't dilute existing shareholders."
On the other hand, this scheme represents a gamble for employees, who must decide whether to give up old options in exchange for new ones six months later. In some cases, it may also create a perverse incentive. "During that period of time, the employees' motivation is totally different than the companies' – they want the stock price to stay down," claims Linda E. Amusa, cofounder of HR consulting firm iQuantic.
Will the trend toward stock options survive economic downturns and the advent of new schemes? Corey Rosen, executive director of the NCEO, suggests that broad-based options will ultimately remain popular. He writes, "Few people accumulate much wealth on salary alone. Companies and their employees have clearly figured out that the road to wealth lies in ownership." Nonetheless, recent trends show that the road is not without its detours and hazards.
====================================================
To get a free copy of The National Center for Employee Ownership's "An Overview of How Companies Are Granting Stock Options," go to
http://www.i4cp.com/2IN04C
The home page of the NCEO is at
http://www.i4cp.com/L20LFa
To read an article on stock options and the Alternative Minimum Tax, see
http://www.i4cp.com/d9WlGL
To see Watson Wyatt's press release entitled "Technology Companies with Highest Use of Stock Options Provided Lowest Returns to Shareholders During NASDAQ Decline," see
http://www.i4cp.com/dzjrnS
Another PR on stock options and price volatility can be found at
http://www.i4cp.com/PFmTZ9
To read the Wired News article "Options: No Execs Need Apply," see
http://www.i4cp.com/yvKdPG
To read "New Economy: Lose Money, Pay Tax," see
http://www.i4cp.com/N7vxZj
To read "Options, Get Your New Options," see
http://www.i4cp.com/Wv4LDT
The Wall Street Journal's homepage is at
http://www.i4cp.com/78IdQZ.
WSJ subscribers can find various articles about employee stock options, including "When Firms 'Reprice' Options, Workers Face Difficult Choice" (June 4), "Options About Stock Options, and a Geography of the Pitfalls" (June 4), and "Europe, a Latecomer, Embraces Options Even as Market Swoons" (May 15).
For a link to the National Association of Stock Plan Professionals, see
http://www.i4cp.com/9txw4h
The Investor Responsibility Research Center, which has reports on stock dilution, can be found at
http://www.i4cp.com/DnvG6g
For a site targeted toward people with stock options, see
http://www.i4cp.com/vLYNWL