After considerable anticipation and speculation, the Financial Accounting Standards Board (FASB) has finally provided the announcement that most expected, and many have dreaded. Still subject to public scrutiny and final editing, the requirement for expensing stock options appears to be imminent and a foregone conclusion. There has been considerable conjecture as to how this will impact the future of executive compensation, as well as compensation in general for those companies that widely use stock options. It is also interesting to note that there appears to have been an assumption that these changes would only impact public companies. However, the changes as published clearly will affect the granting of stock options to all companies, both public and private.
The initial reactions from companies that we have recently surveyed suggest that this is an extremely hot subject, and indications are that many have already changed, or are currently examining alternatives to the granting of traditional stock options. The most immediate impact is that grant sizes have been substantially reduced, and the grants have been more limited in scope, with grants to non-management employees being most severely impacted.
These accounting changes raise the question of why stock options were granted in the first place. Although this seems like a very basic question, it appears that there are a number of interlocking reasons. The first and most significant was to take advantage of the market to underwrite compensation. The options were often seen as a tradeoff for possibly lower than competitive pay, particularly with Silicon Valley type start-ups and cash strapped companies. It was also used as a method to create wealth for both executives and employees by offering them the opportunity to “get in at the ground floor” on an anticipated upswing in stock value. There has always been a strong belief that employee ownership of stock gave them a common interest with shareholders, made them act like owners and think like entrepreneurs. Reality is that unless some form of restriction or stock ownership guideline was in place, many of the options, once exercised and converted into shares, would be sold and the appreciation taken by the employee, regardless of whether this negated some of the inherent tax benefits associated with stock.
We believe that the use of stock options can still be an important component of the “compensation toolbox”. At the same time, we recognize that the underlying use of stock options has been to provide the potential for wealth accumulation, along with a balance of both short-term and long-term decision making, and most importantly, to effectively drive the business. However, in addition to stock options, there are still a number of viable alternatives open to companies that can be used to provide similar advantages. These include other equity based plans, such as Restricted Stock, Restricted Stock Units, and Performance-Based Options. There are also a number of cash-based plans consisting of Stock Appreciation Rights, Phantom Stock, Performance Unit Plan, and Performance-Based SERPs. The most important consideration is that the issues still remain; however, given the number and array of alternatives available, there really is “life after FASB”.
