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To Expense or Not to Expense

With stock options coming under heat, tech companies start to look for alternative ways to boost performance.
Lisa YoonOctober 16, 2002

According to the latest edition of [email protected], the biweekly magazine by the Wharton School of Business, the tech industry is responding to the debate over expensing stock options in classic Silicon Valley-style: look elsewhere for your incentive compensation ideas.

Scrapping the expensing question altogether, a few technology companies are using alternative methods of giving employees incentives to stay and perform well. Among them: Siebel Systems, which is using stock grants and cash, not options; Nvidia, which is using stock; and, which will expense stock-based grants.

Look for more tech outfits to shun options, says [email protected] The parade of corporate scandals in the past year has renewed the call for cleaner and more transparent financials. Critics continue to argue that stock options aren’t the only — or the best — way to motivate employees.

Not that there hasn’t been pressure from the government and standards-setting organizations. Senators Carl Levin and John McCain (R-Ariz.) sponsored a bill to force companies to expense stock options earlier this. The huge retirement fun TIAA-CREF and the Council of Institutional Investors have pressed companies to do it.

And this month, the Financial Accounting Standards Board proposed quarterly and annual disclosure of the cost of options to begin as soon as December. The International Accounting Standards Board has also chimed in in favor of expensing options.

As part of a FASB task force on options accounting in the 1990s, Wharton accounting professor David Larcker was an early proponent of expensing options and stands by his opinion today. “It’s clearly an asset transfer. It’s clearly an expense,” he says. “You’re giving away value from the company to the employee.”

Other incentive plans that have long been expensed could become more alluring to employers if options lose their reporting advantage. “Companies [that] are expensing options will use less of them,” Dan Ryterband, managing director of executive-compensation consultancy Frederic W. Cook & Co., told [email protected] “The reason options were used with such abandon was that they were ‘free’” — i.e. not accounted for as expenses.”

Ryterband of Frederic W. Cook & Co. tells [email protected] other incentive methods–like cash bonuses linked to operating performance objectives– may give more value than options. He also advocates options that vest based on performance, shares based on performance, and restricted shares that vest over time but that can be awarded faster if the employee performs well.

Another alternative is premium priced options, in which workers get more options that come with a higher strike price, according to Larcker. Thus, employee have a strong reason to do what they can to push the stock price higher. He also suggests variably priced, or indexed options, which would have a strike price that increases or drops along with the stock market. The reward would thus be based on outperforming the market.

Don’t look to alternatives as cure-alls, warns Wharton accounting professor John Core. Indexing options may, for instance, supply a “perverse” incentive, moving executives to take inordinate risks. But if options continue to face regulatory and investor hear, employers will have little option but to look elsewhere for their incentive compensation ideas.

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