Human Capital & Careers

Down to a Trickle

Stock options are falling out of favor.
Don DurfeeApril 6, 2004

Four years after the new economy ran out of gas, are companies finally ready to abandon fixed-price stock options? The impact of expensing, underwater options, and shareholder attempts to block companies from issuing new shares appear to be driving many to do so.

A new survey conducted by Deloitte & Touche found that three-quarters of the 165 S&P 500 companies surveyed plan to shift away from stock options, and 17 percent have already dropped them entirely. Companies that have announced such intentions include Dell; Microsoft, which now emphasizes restricted stock; and IBM, which will give its top executives options that vest only if the company’s shares rise by 10 percent or more. In place of these options, companies are considering alternatives such as cash, restricted stock, and phantom stock (bonuses tied to an increase in stock price).

“As the economy began to slow, stock options became less of a motivation for employees, so we have had to look at other ways to incentivize,” says Mike Maher, a spokesman for Dell, which has cut the number of options it grants by about half for two years in a row.

Many companies have been decreasing their reliance on options in anticipation of a rule recently proposed by the Financial Accounting Standards Board, which would require companies to start expensing options in 2005. More immediate pressure is coming from shareholders. Last year the New York Stock Exchange and Nasdaq altered their listing requirements to require companies to seek shareholder approval for changes to equity compensation plans, including the issuing of new shares to cover upcoming grants. (Formerly, such plans required only board approval.) The D&T study shows that two-thirds of companies will run out of shares within 24 months.

Big institutional investors—which worry about dilution from large options grants—are using their new power to oppose excessive compensation. According to Peter Clapman, chief counsel, corporate governance, at TIAA-CREF, his organization has recently voted against roughly 35 percent of compensation plans and will likely oppose a similar number in the future. “Plans should be performance-based, not just a reward for a general rise in the stock market,” he says.

Whether the move away from stock options will survive the market’s upswing is anyone’s guess. Michael Kesner, a D&T principal in Chicago, believes that independent compensation committees and determined investors make a return to the excesses of the 1990s unlikely. And who knows? If overhauling compensation plans helps drive better corporate performance, boards may find they prefer having fewer options but more choices.