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Stock options--for dummies?

CNET News.com's Michael Kanellos writes that if stock options are indeed doomed to extinction, their death won't mark the end of the entrepreneurial culture that they spawned.

Stock options--a form of job compensation that has made millionaires out of many--appear to be headed toward extinction. But their death wouldn't mark the end of the entrepreneurial culture that they spawned. Last week, Microsoft announced a new compensation plan under which employees will receive shares of stock, rather than options. The catch? Workers will likely get far fewer shares than they did options. Opponents immediately contended that the change would dampen the tech world forever. People would no longer be enthusiastic about working 12-hour days without the option carrot dangling before them.

The urge to launch a start-up would shrivel up, they also warned. Silicon Valley got its start because Fairchild Camera and Instrument wouldn't give its engineers stock options. Defectors went onto found Intel, National Semiconductor and Advanced Micro Devices, among other companies.

These fears, though, seem overblown. Overall, rank-and-file tech workers contacted have applauded the move. And so far, there have been no reports of Redmond, Wash., residents exclaiming, "What? You're getting rid of options in favor of stock? That's it--I'm going to Unisys."

Although the extra money options bring is always welcome, very few people come away from the experience of exercising stock options feeling good about themselves. Somehow, you always mess it up.

First, there is the pricing game. No matter what happens, someone in the office always manages to unload his or her shares at a higher price than you do.

Somehow, you always mess it up.
No selling strategy ever succeeds twice. One tech veteran recalled that at his first company, he sold his stock right at the start of the "open period" (the time period the Securities and Exchange Commission allows employees to buy or sell shares). The stock was plummeting. He felt good about being able to sell before it hit rock bottom.

The next day, the price skyrocketed. Traders, he learned later, knew workers would rush to unload shares, so they stayed out of the market that day to exploit panic selling.

At his next job, he abstained from activity on the first day of the open period. That day marked the all-time high for the stock price.

Then there are the tax issues. Those who sell early, pay a higher tax rate and, occasionally, penalties for a failure to prepay income tax.

Still, it's doubtful that this shift will create Soviet-style workplace laziness.
Those who buy company stock, however, have to pay the dreaded Alternative Minimum Tax (AMT). It's an ornate section of the tax code, but suffice it to say that from 2000 to 2002, many executives had to pay huge tax bills on "gains" on shares--gains that had already vanished because of a slide in the stock market. Sometimes, option buyers discovered they would have been better off financially, if they had never gone to work during those years.

By contrast, the Microsoft plan brings certainty: Employees get shares of stock over a five-year vesting period. They must pay income tax when they receive the shares, but they can accrue long-term gains without laying out their own money (a requirement with options) or forking over for AMT. They just have to hold onto them. The potential for stupidity remains--but it's far lessened.

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Senior department editor Michael Kanellos scrutinizes the hardware industry in a weekly column that ranges from chips to servers and other critical business systems. Enterprise Hardware every Wednesday.




The downside, of course, is that employees get fewer shares than options. Because options aren't counted as an expense, it's a form of compensation that's free for many tech companies. Shares given to employees will have to be placed on the balance sheet, which means compensation could be lower.

Still, it's doubtful that this shift will create Soviet-style workplace laziness. After all, employees will still get equity which, depending on the amount given and the company's fortunes, could still make an individual a millionaire. It's not as if companies that adopt equity plans will instead try to motivate their people by giving them shoes or early entry to the company rummage sale.

Start-ups will continue to flourish as well. Tech remains one of the few industries where creative breakthroughs can lead to unexpected, sudden wealth. Getting in on the ground floor will remain as strong a motive as ever.