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Options Expensing Prompts Fresh Look At Compensation
09/01/03
By: Tom Harbert, Electronic Business Magazine
Microsoft Corp.'s surprising announcement over the summer that it would cease giving stock options to its employees has high-tech executives scratching their heads, wondering whether and how to change their company's compensation strategy.
In July the Redmond, WA-based company announced that it would start expensing stock options and grant employees restricted stock instead of options. In addition, it announced a novel arrangement in which investment bank J.P. Morgan would offer to buy the underwater options of Microsoft employees.
This huge move by one of the giants of technology is rippling throughout the industry. Not only did a company that is legendary for making its employees millionaires abruptly end the program responsible for it all but it also seemed to revive an old equity-based compensation method—granting restricted stock—that had been left in the shadows when stock options became all the rage.
The announcement is prompting tech companies to reexamine long-held assumptions about compensation. "Even companies that are doctrinaire opponents of expensing stock options are running the numbers to see where they will stand" if the Financial Accounting Standards Board (FASB) starts requiring them to expense options, says Ted Buyniski, a principal at Buck Consultants Inc., headquartered in New York, NY. More than 85% of Buyniski's clients are high-tech companies.
The first thing to determine is whether to start expensing options now or wait until the FASB requires it, which Buyniski believes is likely.
Once a company starts expensing options, it should "use this as an opportunity to step back and completely reevaluate its compensation strategy," says Buyniski. For many companies, stock options have been a no-brainer, because they are the only equity-sharing arrangement that does not trigger a charge against earnings. But if options start triggering a charge, companies will begin looking more closely at other arrangements, notes Paul Dorf, managing director, Compensation Resources Inc., a consultancy in Upper Saddle River, NJ.
These arrangements include direct stock purchase plans, restricted stock, phantom stock and stock appreciation rights (see box, below). Companies should analyze their own situation and determine which vehicle will be the best for them. For pre-IPO and newly public companies, stock options will probably continue to be the best choice, because they offer the biggest potential reward to employees. For example, Hier Design Inc. has no plans to change its stock option plan, says Pete Teshima, chief operating officer of the Santa Clara, CA-based start-up. "We need to build a business here," he says. "It's expected that we offer stock options."
But more-established companies that are not likely to experience as high a growth rate may want to consider other compensation schemes. For example, they can increase cash compensation, as Round Rock, TX-based Dell Computer Corp. has done, or they can let employees trade in stock options for restricted shares.
This process of reexamining compensation strategies may open up a whole new era of performance-based compensation, say experts. Dorf expects to see companies start using performance-based stock programs quite creatively. And Buyniski sees a potential silver lining. If stock options no longer carry such a strong accounting advantage, "that will free companies to structure their compensation programs so that they really do support the company's goals," he says. "Potentially, it could create a market in which pay and performance are linked better than they ever have been."
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