Opting Out of Stock Options

Mandatory expensing and aggressive shareholders are bearing down on companies with broad-based employee stock option plans. Since 2003, 58 percent of employers have reduced the number of employees who are eligible for stock option grants, and 61 percent have cut the number of shares granted, according to a new survey of 258 companies from Mercer Human Resource Consulting.

    “Long-term equity plans are declining, in large part because of the new expensing requirement for stock options, and are not being replaced dollar-for-dollar,” says Steven Gross, Mercer’s rewards practice leader.

    Nearly 15 million U.S. employees hold stock options, according to a survey conducted by the National Opinion Research Center of the University of Chicago. Broad-based programs are most prevalent in the tech sector but are also commonly used in the communications, finance and manufacturing industries. Among public companies with 500 or more employees, 23.4 percent use broad stock option plans.

    Companies must now include the fair value of their stock option grants in their income statements under Financial Accounting Standards 123(R), beginning with the first reporting period after June 15, 2005, for public companies and December 15, 2005, for private companies.

    Cisco Systems fought expensing long and hard and has no intention of changing its long-standing policy of providing stock options for every employee, but it will cut back on the number of options awarded. “In November, we have to go to shareholders for additional shares, and we’ll be limited by the level of dilution they are willing to incur, and by expensing,” says Kate DCamp, senior vice president for human resources.

    Cisco will not introduce new vehicles to replace the value lost when the number of options is reduced. “But we will make sure that we have a competitive total offering,” DCamp notes. ” ‘Competitive’ is the watchword here, not ‘The same as it might have been in a different scenario.’ Years ago, if you worked for Cisco, you received stock and it split a number of times and rose dramatically and you made a lot of money. But that was then, and this is now.”

    Cisco granted 195 million option shares to employees for fiscal year 2005, mostly merit-based, with a small portion for new hires. The company used the Black-Scholes valuation method for expensing in its October statement, but it is still pressing for acceptance of an alternative market-based valuation model.

    A 2005 survey of 340 companies by Deloitte found that 75 percent have already reduced or are reducing the number of options granted. The survey also found that 8 percent of public companies are eliminating their employee stock purchase programs and another 51 percent will reduce the employee discount. Almost 30 percent plan to use the safe harbor provision that limits discounts to 5 percent but allows companies to avoid any expense recognition.

    Deloitte’s study also found that 91 percent of companies have made no change in options eligibility for top management.

    “Most U.S. companies are continuing to use options, but for executives only,” DCamp says. “The problem is that inventions are carried out by employees, not executives.”

    With Asian nations quickly moving toward equity-based compensation, DCamp believes that the decline in stock option grants among U.S. companies will have long-term negative effects on their global competitive position.

Workforce Management, October 24, 2005, p. 36 — Subscribe Now!