Keeping Options Afloat

On March 6, The Walt Disney Co.'s shareholders will gather in Fort Worth for one of the first major annual meetings of the year. And, as always, CEO Michael Eisner's pay package will be a favorite topic. Last year, the famously well-compensated chief Mouseketeer took home a tidy base salary of $1 million, and a whopping bonus of $11.5 million. This in a year when Disney shareholders saw a return of just 5 percent.

Still, the bigger bone of contention looks to be Eisner's stock option compensation. In 1996, Disney granted him 24 million stock options vesting over the subsequent 10 years. He has already realized gains of $60 million on 3 million exercised options, and his as-yet unvested options were valued at $267 million at the end of September. This year, Disney is seeking shareholder approval to reserve another 100 million shares for issuance under the companywide incentive plan, but it may not get it. In fact, if a shareholder proposal to limit the number of options granted to senior executives is passed at the meeting, Disney may have to revamp its entire incentive plan.

The Disney meeting could foreshadow a lively proxy season this spring, say corporate-governance experts, with stock-option compensation the hottest topic. "It's the number-one issue this season," says Cynthia Richson, investor responsibility program officer for the State of Wisconsin Investment Board.

The heart of the issue is what to do about last year. Nasdaq posted its worst year ever in 2000, meaning thousands of senior executives and rank-and-file employees are sitting on options with strike prices that are far above the current share price. Those options, particularly at technology firms, are now less a motivation than a reminder of how much they lost last year. And corporate managers now have to determine how to retain and motivate employees without incurring the wrath of investors. "How to deal with underwater options is the 600-pound gorilla of the compensation world right now," says senior executive compensation consultant Yale Tauber, of New York­based William M. Mercer Inc.

Corporate-governance purists like Nell Minow, editor of The Corporate Library, a Washington, D.C.-based Web site that covers executive compensation and corporate governance, say the solution is simple: Do nothing. "Management should suffer along with shareholders," says Minow. "Options are supposed to rise and fall. If they don't, there's no credibility to the granting of them."

BLOOD IN THE WATER

Maybe not. But pay-for-performance principles aren't what most corporate managers are thinking about. With the still-tight labor market, and the potential for employees to get more cash or new lower- priced options elsewhere, they're more worried about the headhunters who smell blood in the water. "It's a lot easier to lure people now," says Paul Dinte, CEO of executive recruiter Dinte Resources Inc., in McLean, Virginia. "I've had more calls in the last three months than at any time since 1992." Adds John Wilson, a San Francisco­based financial officer with executive recruiters Korn/Ferry International: "There's a lot of pressure within organizations that have been slammed to do something to retain top talent." Not surprisingly, many firms are weighing whether to reprice, replace, or otherwise restructure their option plans to keep the troops happy.

Some are starting with small steps. San Jose, California-based Cisco Systems Inc., for example, whose nearly 20,000 new hires from last year are holding options priced almost 50 percent higher than the current share price, decided to grant this year's options last November--two months earlier than the previous year. It is also considering stepping up the frequency of its grants to a quarterly or monthly basis.

Others have taken more drastic measures. A November survey of dot- coms and technology firms by San Francisco­based consultancy iQuantic Inc. found that 80 percent of the companies surveyed had underwater options; of those, 50 percent have already issued new grants or made interim awards to employees. And a broader survey of CFOs conducted in December by the Fuqua School of Business at Duke University and Financial Executives International determined that 43 percent of public companies that issue stock options intended to compensate executives for their underwater options.

The simplest cure for underwater options, of course, is to reprice them, as Amazon.com did in early February. However, with Financial Interpretation Number 44 (FIN 44), the Financial Accounting Standards Board has essentially ruled that out. The new rule forces companies to use variable accounting treatment for repriced options, which can result in large charges against earnings, if the value of the shares (and repriced options) rises.

Rockville, Maryland-based software maker Manugistics Group Inc. is one of the few companies that have already had to deal with FIN 44, which applies retroactively to December 15, 1998. In early 1999, the company received shareholder approval to reprice options to purchase 3 million shares, after the stock's collapse the previous year. The good news: Manugistics and its share price have made a remarkable recovery. But in the last two quarters, the company has taken a charge of $21 million and a gain of $6 million because of fluctuating value of the repriced options. And with the stock up significantly in the last several months, the company will likely be booking additional charges in coming quarters.

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