Tech Industry

Hey, they really did get rich

A newly published book takes a contrarian view of the stock option culture, arguing that employees at technology companies made out quite nicely, crash or no crash.

With so many tech stocks crashing the last couple of years, the conventional wisdom is that people working in the technology industry wound up with worthless options. But a new book argues that tech employees actually made out pretty well during the boom years, raking in some $78 billion in option profits.

"In the Company of Owners: The Truth About Stock Options (And Why All Employees Should Have Them)," by Joseph Blasi, Douglas Kruse and Aaron Bernstein, finds that nonexecutive workers at the top 100 Internet firms made an average of $425,000 in stock option profits between 1994 and July 2002.

Blasi and Kruse are professors at the Rutgers School of Management and Labor Relations, while Bernstein works for Business Week.

In the 100 largest firms that derive more than half of their revenue from the Internet, stock options give employees an average 19 percent ownership, the authors found. By comparison, employees working for the top 100 companies on the New York Stock Exchange own just 2 percent of their companies.

"Never before in the history of the modern corporation has an entire industry handed over so much potential ownership to a broad cross-section of employees," they say in the book.

"In the Company of Owners: The Truth About Stock Options" is being released at a time when stock options no longer carry the cachet they did in the late 1990s. Some economists and policy analysts contend their value as a tool for motivation is outweighed by their cost to shareholders.

Critics argue that options allowed companies to compensate executives lavishly without ever accounting for the expense in their books. New proposals would require companies to account for the options, a move which defenders of the current treatment say could seriously hurt some companies' bottom lines.

CNET News.com spoke with author Joseph Blasi about the book's findings as well as the past and future of stock options in the technology business.

Q: Stock options certainly didn't start with tech companies. Can you talk a little bit about the history of stock options?
A: Doug Kruse and I did a book in 1991 that looked at broad corporate ownership in mainstream companies, like Procter & Gamble. Over its history, Procter & Gamble has been between a quarter and third employee-owned. Procter & Gamble in the late 1800s was one of the main companies in the country and the world pushing profit sharing. William Procter basically invented profit sharing for himself and the company in the last 1800s.

The vast majority below executive line workers sold and took profits.

The new story for the 21st century in corporate ownership and corporate models is this extensive broad-based use of options in high-tech. You can think of four waves in terms of tech. The founder wave with the idea of broad wealth sharing occurred in companies like HP and the early history of Intel. Then you can think of the developer wave, and companies like Microsoft and Apple. Then there is the more recent wave and what the book focuses on with the high-tech 100. At the end of book, we look at the next wave, which we see as biotech.

Your book says tech employees made on average $425,000. That number seems enormous. Is that just in paper profits, or did workers really get all that cash?
We looked at nonexecutive employees, meaning below the top 5 executives, because top executives in most companies get about the top 20 percent of the options. This is an estimate based on what companies have said in option exercise filings. It's also based on a number of studies indicating that when you get to lower-level executives, managers and employees, they tend to exercise and sell as a general rule. We presumed that all the options exercised were sold and employees took the cash profit. If you think 10 percent didn't exercise and sell, you can lower the number. But all the evidence indicates that the vast majority below executive line workers sold and took profits. It's very clear that workers in companies like Microsoft and Intel and Apple and many other tech companies in the first wave made extensive, extensive wealth through broad-based stock options in the '80s and '90s.

So what does that mean for corporate ownership?
On average, the non-top 5 executive employees at the tech companies control 19 percent of equity through stock options, and about 2 percent through employee stock purchase plans. That compares to 2 percent for traditional Corporate America, where most employees have no options. A system of sharing the benefits of corporate growth has been developed in high-tech, and it's vastly different than the traditional way of organizing a corporation.

What does this mean for shareholders?
Sharing the wealth While we were writing the book the tech sell-off took place, and a lot of extreme skeptics asked, "Did this employee ownership help drive the sell-off, and did it dilute (value)?" We did a lot of field interviews and focus groups with regular employees. We concluded that in these kinds of knowledge companies, where product and profits are between the ears of employees and in their relationships with customers, that giving employees a piece of the action is key to developing information and pleasing customers. We don't think these companies could have done what they did without this wealth-sharing system.
In virtually all these companies the founders control less equity than employees as a group, which means the founders decided to dilute their own stake. We don't think they would have done that unless it was absolutely necessary.

Is there any evidence that employee equity drove the sell-off?
We couldn't find any evidence. It appears to us that the tech sell-off was driven by all the factors pundits have said: overcapacity, a general bubble in the market, and excessive positive predictions about how quickly broadband would spread. We don't think that broad-based ownership could be blamed.

We don't think these companies could have done what they did without this wealth-sharing system.
There's no question that shareholders were probably very angry when they saw the option profits of tech company employees compared to their own losses. But it's important to realize that a lot of nonemployee shareholders made tens of billions themselves because they had the right timing on when to sell.

Some people think the real cost to shareholders isn't in granting the options. They think the true cost of options isn't being calculated right now, and that companies should be required to treat options as an expense.
Options have a cost, and their cost is in dilution to shareholders when they're exercised. When they're exercised, companies have to report that and they have to report diluted earnings per share. We think reporting should be more extensive and clear for shareholders. But the cost of options to shareholders in terms of dilution is already being reported.

The current debate is whether it should be a compensation cost like wages. We're not accountants, but our view on that is that--especially for nonexecutive employees--broad-based stock options are a form of long-term risk sharing. We think it's sufficient to report accounting for them as a long-term risk. We think expensing is an opaque solution to the real problem, which is that executive compensation has to grow to astounding heights, mostly through options, in traditional Corporate America. All expensing does is force Corporate America to hang out a sign saying, "This is how much it is."