Technology

Addicted to Options

Debate over expensing stock options rages on, but do established IT companies really need to dole them out?
John GoffJune 5, 2003

According to a report in the well-respected San Jose Mercury News (well, we like it), tech salaries decreased in 2002. In fact, the Mercury News reports that the highest-paid executives at Silicon Valley’s largest companies took home $1 billion last year.

While that may seem like a nice tidy sum, keep in mind the total (which included salary, bonus and estimated stock options gains for 754 executives), was only about one-fifth of the record $4.7 billion tech executives made in 2000.

Thomas Siebel, CEO at Siebel Systems, topped the survey with total 2002 income of $34.6 million. Much of Siebel’s haul came from exercising stock options. Same thing for the number two on the list, Scott McNealy of Sun Microsystems (who made nearly $26 million last year after cashing in $25 million in options.) Craig Barrett, CEO of Intel, came in third with a little over $19 million in compensation in 2002.

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It remains unclear what would have happened to the income of the employers of those three chief executives if the companies had been required to expense those stock option at the time of the grants.

What does seem clear: the continued harping of CEOs at established IT companies about how stock options expensing would do serious damage to the tech sector is a bunch of hooey. Expensing of employee stock options will cause some strain, no doubt. According to a recent survey by the Associated Press, the expensing of stock options would have reduced earnings at the top 35 U.S. technology companies by $9.8 billion last year. That works out to roughly $250 million per company.

That’s a hit, true. Moreover, the expensing of stock options would be a shock to the system for the tech sector. In Silicon Valley, stock options are a way of life (some would say addiction). And the granting of stock options to employees is about the only way tech startups — emphasize startups — can attract and retain top workers. Indeed, without stock option grants, managers at fledgling IT businesses would be hard pressed to compete for tech talent with more established companies. Really, what would their pitch be? “We won’t pay you much, but you’ll work long hours.”

But mature, cash-flush tech companies like Siebel and Intel would seem to have the financial wherewithall to pay big bucks to attract and retain employees. And by expensing employee stock options, their financial statements would be a much truer indicator of the health of their businesses. That’s not just us saying that either. Alan Greenspan, Warren Buffet, and Robert Herz have all reportedly come down on the side of expensing worker stock option grants.

But for now, generous granters of stock options continue to dine at the trough: they give away something of value (stock options), yet they don’t treat that giving-away as an expense. Strange stuff, considering that CFOs who receive stock options almost always think of the grants as compensation. But when it comes to the accounting treatment of those grants… well… all of sudden they’re handled as something other than compensation.

Backers of that practice — and consultants who make money off backers of the practice — say stock option grants help align the interests of workers with shareholders. That, they claim, improves corporate performance.

Maybe. But consider this: most technology companies have handed out massive amounts of stock options to workers over the past few years. Those companies have not exactly been lighting up the tote board of late.

And despite propaganda to the contrary, the majority of workers do care about their jobs, do put in long hours, and do good work — and would do so with or without stock options. As for indifferent employees: stock option grants aren’t real likely to convince them to ratchet it up another level.

The real question now is will anybody put an end to the stock option free lunch?

It’s not looking real likely. FASB does appear to be leaning toward requring all companies (with the exception of non-public startups) to expense employee stock options. But a new bill in Congress sponsored by — surprise, surprise — two California lawmakers would place a three-year moratorium on any revision of the current GAAP method for stock option accounting (see Congress, FASB in Stock Option Flap.”).

While tech executives in Silicon Valley must be thrilled with HR 1372, rule-makers at FASB are probably less enthused. If the proposed legislation passes — and it’s got a shot — FASB’s recent initiative to get companies to expense stock options would be derailed.

It wouldn’t be the first time. About ten years ago, the standards-setting board got very close to requiring companies to expense stock option grants. As you may recall, industry forces managed to scuttle the idea — mostly by getting Congress to threaten to dismantle FASB if it went through with its plan.

Of course, if FASB had managed to get its program through ten years ago, tech companies wouldn’t find themselves in the jam they’re in now. We’re just saying.

Tech Spend: Still Sluggish After All These Years

Apparently, the real lesson learned from the recent rise and fall of the technology sector: don’t spend a lot on technology.

The fact is, three years ago, you couldn’t swing a dead cat without hitting a CFO extolling the virtues of the Web and push technology and CRM software. Indeed, most finance chiefs we interviewed at the time all said the same thing: technology was their differentiator, their competive advantage, the way and the light. And many of these were finance chiefs at more traditional businesses, not dot-coms.

Nowadays, corporate executives seem to have completely backed off the tech-is-god spiel. Even executives at fast-growing companies — often big proponents of IT spending — seem to be applying the brakes on tech spending.

In fact, in a recent study conducted by PricewaterhouseCoopers and BSI Global Research, CEOs at fast-growing companies said they will restrain their IT spending over the next twelve months. What’s remarkable about the survey is that these same CEOs predict their corporate revenues will grow at a 16.4 percent clip. Conversely, these CEOs say they will only jack up their IT spending by 9 percent — and that comes on the heels of several years of flat tech spending.

“In today’s sluggish economy, many [fast-growing businesses] and other companies are concentrating on attaining the full capability from their existing IT platform, before making more-extensive investments,” notes Paul Weaver, global technology industry leader for PricewaterhouseCoopers. “There is a reluctance to make major new commitments, and a resistance to the temptation of new applications.”

Not great news for makers of new applications. In fact, nearly 60 percent of the respondents said they simply have no need to upgrade or improve their current IT capabilities right now. The vast majority of those who do plan to make some sort of tech improvement over the next twelve months say they’ll pay for it out of their current budgets.

Interestingly, PwC asked all survey respondents to name the hot new IT areas they believe will blossom over the next few years. The number one answer? Faster data transactions, meaning Ultra Wide Band networks.

After UWB, respondents listed security applications, wireless networks (LANs) and XML/Web services as the most important technologies for businesses in coming years. Of note: internet telephony, which has been hyped by telcos for years, was way down on the list, as was grid computing.

“There’s a lot at stake here as limited dollars chase an impressive array of new IT applications,” says Weaver. “A more-buoyant economy will need to emerge soon, in order for a larger number of these new IT areas to have a fighting chance to survive and prosper.”

That poses a big risk for the champions of those technologies. It also poses a bit of a risk for CFOs who sign off on IT purchases. Recruiters say backing a hot technology that ultimately doen’t pan out is one sure-fired way to tarnish a CFO’ career.

So where do you place your bets? By our admittedly dim lights, the technologies that will actually change the way finance managers work in the next three years are XBRL and wireless computing. In a few years, all financial software will be XML-enabled, and all corporate filings — to banks, the SEC, etc. — will be in the XBRL format (see “Educating Data.”). During that same time, true wireless portable computing will become as commonplace as open-toed sandals in dry climates.(see What is a Centrino, Anyway?”)

Bytes

IBM, the world’s largest software maker, saw sales of its database software increase by about 17 percent last year. That, despite a serious cut back in corporate technology spending. According to a Gartner study, IBM garnered a 37 percent share of the database market, while rival Oracle slipped to a 27 percent share. Microsoft, which has been picking up ground on the top two, holds about a 19 percent share of the database market.