A fair share

By Lisa M. Bowman
Staff Writer, CNET News.com
July 14, 2003, 4:00AM PT

Microsoft did something last week that was unthinkable in Silicon Valley: It did away with stock options.

Long a hallmark of the technology industry's penchant to bet on long shots, stock options promised to turn legions of workers into overnight millionaires. However, many employees have been left holding thousands of worthless options despite their hard work--a bitter and demoralizing reminder of unrealized dreams.

"The issue of perspective is key here," said Michael Garretson, a past chairman of the Career and Workforce Policy Committee of the IEEE-USA, an organization that represents technology workers. During the boom times, a lot of employees would have chosen the riskier options over the more stable stock grants, Garretson said. But many have learned their lesson the hard way, he said: "Most technology people have a bucketful of options that are worthless right now."

But as the industry searches for new ways to reward its work force, will other companies rush to follow the lead of bellwether Microsoft? The answer depends on a variety of factors.

It's tough for a company to make a one-to-one comparison of stock-based compensation plans, if it does decide to drop options. A lot depends on the price of the stock when it vests and the number of shares an employee will get compared with the number of options they used to receive.

"It's trendsetting, because anything that Microsoft does opens the doors for other companies to do it," said Bill Coleman, senior vice president for compensation at career Web site Salary.com. "But not every company can do it."

Other technology stalwarts such as Intel, Oracle and Sun Microsystems said they have no plans to scrap their options plans, adding that such programs can help people share in their employer's success.

"Employee ownership through stock options remains a key component of Sun's long-term compensation programs and, more broadly, a vital driver of an innovative and entrepreneurial technology sector," Sun spokeswoman May Goh Petry said. The company focuses its stock plan on the rank and file, she said, allocating 87 percent of all options to those who are not in senior management.

Nevertheless, at least on its face, a switch from options to outright grants of stock seems to make a lot of sense. The success of options as a form of compensation relies on a steady increase in share price, something that could hardly be assumed in the last few years. So rather than continue doling out options that might end up being worthless, Microsoft decided to just give stock priced at current market levels to workers.

"At least you know you're getting something," said one newly hired employee at Microsoft, who asked that his name not be used.

Unlike stock options, grants of actual stock are always worth something--unless the company goes bankrupt. The catch is that workers usually get far fewer shares than they would have gotten as options.

A stock option gives an employee the opportunity to buy a share at a predetermined "strike price." If the share price rises above this level on the open market, the employee is able to buy the stock at the original strike price and then sell it at the higher level. If the market price sinks, the employee does not lose anything as long as he or she never bought the stock--but does not gain anything either.

There is a crossover point at which the options become much more valuable than outright grants, provided the company's stock price continues to rise.

For example, suppose an employee has 100 options with a strike price of $10. If the stock hits $25 on the open market, the employee can buy 100 shares at the $10 strike price for $1,000 and then immediately sell them at the $25 market price for $2,500--a profit of $1,500 before taxes.

There's only a gain, however, if the stock price goes up. If those same options were awarded at the height of the dot-com boom, and the price of the shares fell after the boom to $1 or less on the open market, then that would render the options worthless, or "underwater," because they are worth far less than the $10 strike price it would cost the employee to buy them.

Silver lining?
Some optimists say the low market prices of the post-bubble era are actually good reasons to stick with stock-option programs.

Oracle Chief Executive Larry Ellison, for one, has said his company would not follow Microsoft's lead because its shares have fallen more from their boom-time highs than Microsoft's have. That means Oracle's stock price has a greater potential for gain. If the value of Microsoft's shares doesn't continue to climb significantly--and Ellison believes it won't--then options to buy its shares at current prices become less valuable and less of an incentive for new employees.

"What makes sense for Microsoft doesn't make sense for us," Ellison said of Microsoft's move. "But it's a very clever thing to do."

An example of the difference between stock options and awards was shown in an internal corporate memo sent to Microsoft employees Wednesday. The memo, seen by CNET News.com, stated that employees at a certain level--who would normally be given 1,320 options--would get 325 stock awards. Compensation experts said that award is in line with a typical industry ratio of one share grant for every three or four options.

The recently hired Microsoft worker said that he would earn about $8,775 from the grant of 325 restricted shares, if the stock is still at its current market price of $27 when it vests in five years. If the price doubles, he would earn twice that amount, or $17,550.

By comparison, if he had the 1,320 stock options with a strike price of $27 and the market price remained the same, his options would not have brought in any gains. But if the market price were to double, the stock options would be worth $26,865 more than the fewer shares of outright stock he had been given.

Still, many Microsoft workers are cheering the move, mainly because it offered some semblance of security after three rocky years of stock fluctuations.

"This is not a high-risk, high-reward place, but it's a great place to work on a long-term, stable career," said the new employee who works in marketing for Microsoft's next operating system. He had seen three rounds of stock options lie unused at other companies because those businesses never went public.

Others are thankful to be getting something on top of their salaries, but long for the kind of lucrative option prospects that initially drew them to the industry. "It's good, but it's sad," said one Microsoft program manager, who held many underwater options.

It's sad, the employee said, because the change underscores that Microsoft has morphed from a funky technology wonderland, where employees could dream about cashing in big, to a stodgy company like rival IBM, a place where you settle in for 10 or more years, if not the rest of your career.

"Everyone knew that, but this is sort of making it official," said the employee, who's been with the company for five years.

Sizing up the options
But Salary.com's Coleman sees Microsoft's move as anything but stodgy. He said most old-school companies would have been more conservative in the scope of stock grants, offering the new program only to executives and possibly excluding lower-level workers altogether. The software maker's plan to continue offering stock incentives across the board means that it is still willing to experiment, he added.

Not all companies, though, have the capability for such experimentation. Intel spokesman Bill Calder noted that stock options remain a key compensation tool for smaller companies that can't afford to hand out stock directly.

"In the case of small start-ups, it's absolutely crucial," he said. Like other supporters of stock options, Calder said they are needed to attract the best employees, adding that Intel gives 97 percent of all options to its rank and file.

Calder and others fear that the general public is looking to blame stock options for recent high-profile corporate scandals at companies such as WorldCom. He said the problem instead is excess compensation of executives and general greed.

"You have to ask yourself, 'Does expensing stock options really solve that problem?'" he said. In its plan announcement, Microsoft said it would "expense" its remaining stock options, a controversial accounting practice that many companies have said would unfairly and inaccurately hit their earnings.

Amazon.com has decided to expense its stock options and has begun giving employees stock outright, which must be taken account of in the company's earnings. Spokesman Bill Curry said nearly all of the Internet retailer's 7,700 employees have signed up for the program, which was introduced last fall, and it has transferred about 3 million shares to its workers in 2002 alone.

Curry said the plan was designed to treat staff members as if they were "the company's owners" and to align the interests of external shareholders as closely with internal employees as possible.

Martin Staubus, director of consulting for the nonprofit Beyster Institute for Entrepreneurial Employee Ownership, believes that companies will increasingly turn to a smorgasbord of incentives--including options, stock grants, cash and even souped-up retirement plans--rather than follow any single trend as they did with stock options in the 1990s.

"I don't think there is going to be a next big thing," said Staubus, whose organization advocates the introduction of more employee stakeholders in businesses. "Companies are going to assess a menu of choices."