Tech Data Puts Ceilings On Some Options? Future Gains

06/14/05
By: Loren Fox, Base and Bonus

Tech Data Corp. is experimenting with a form of stock options that caps the gains executives can realize upon exercise.

The $19.8 billion technology distributor is believed to be the largest company to use maximum value options as part of a long-term incentive plan. Tech Data made its first grants of maximum value options at the end of March. This included more than 290,000 options granted to the top five executives.

The workings of this unusual equity award are becoming more topical as companies face a January deadline for the mandatory expensing of stock options. Limiting the potential upside of options limits their value, so maximum value options limit the expense that companies must record. Tech Data directors note in their May proxy that they expect the caps on poten- tial gains to lower option-related expenses.

Capping option gains could conceivably help stave off a frequent criticism of options ? that they generate windfall profits for executives that are disproportionate to the value they generate for shareholders. Further, says consultant Donald Delves, maximum value options are "a good idea" because they "bring into closer alignment the expense to the company and the perceived value to the recipient."

Employees have always perceived their stock options to be worth less than their actual value. Delves says the employees' perceived value may be as little as half. This means that a company must record an expense for the options that at the time is far greater than the motivational and retention value they deliver.

Experts say this award seems to make most sense at growth companies, where option gains might reasonably be expected to yield robust profits for executives. Unlike mature-stage companies, which don't tend to have substantial growth, younger companies with far greater growth potential can more easily justify the cap because if uncapped, the expense might be too high.

Yet limiting the upside of any compensation plan typically carries motivational risks. Skeptics point out that limiting rewards might dampen executives' zeal to perform. "I would think the executives would not be as motivated to drive that company," says Paul Dorf, managing director of Compensation Resources.

The idea of capping option gains has not caught on in the investor community. Many shareholders see options as focusing the executives on boosting the stock price, so capping the upside limits that incentive, says Carol Bowie, director of corporate governance research at the Investor Responsibility Research Center. "That's not how shareholders will approach the need to provide discipline in executive compensation," Bowie says. Instead, shareholders tend to favor the use of fewer traditional options or the use of performance-linked options.

A handful of other companies are, at the very least, open to the idea. In October, shareholders of Applera, a $1.7 billion biosciences company, approved an equity incentive plan that empowered the committee to grant maximum value options. And in March, shareholders of Martek Biosciences, a $148 million company developing products from micro-algae, also approved an equity plan that allows maximum value options.

But maximum value options haven't caught on broadly. The mandatory expensing of options in 2006 may yet convert a few more companies. But industry observers expect them to remain a niche in the equity incentive universe. Even those who like the idea don't project widespread adoption. "Attention has shifted elsewhere. If options were seen as the only way to go, I think you'd see a lot more companies try this tweaking to their options plans. But that's not the way the winds have gone," says Blair Jones, senior vice president at Sibson Consulting.

Instead, many companies have reacted to options expensing and criticism of options by diversifying away from options largely or entirely, adding alternative equity vehicles such as restricted stock and performance shares.