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>From this weeks Businessweek.
JW
http://www.businessweek.com/1999/99_49/b3658006.htm
The Hidden Costs of Stock Options
Companies may be reporting pay increases that are astonishingly low, given
the tightness of labor markets. But that doesn't tell the full story about
how much they are really paying to hire and retain good help. More than
ever, employees of all ranks are getting a little bit of equity in their pay
packets. A recent study of 1,300 companies by Watson Wyatt Worldwide shows
that almost 19% of employees are eligible for stock option grants, up from
12% last year--although being eligible and getting options aren't the same
thing. ''There's no question it continues to be the perk of choice,'' says
John A. Challenger, president of outplacement firm Challenger, Gray &
Christmas Inc. Best of all, from an accounting perspective, regulators don't
require companies to include stock option grants in their compensation
costs. Translation: There are no footprints at the bottom line.
But what do these options packages really cost? A team of accounting pros at
Bear, Stearns & Co. recently set out to discover just that. The group,
consisting of Bear Stearns analysts Pat McConnell, Janet Pegg, and David
Zion, studied earnings reports of companies in the Standard & Poor's
500-stock index to come up with an estimate. Although companies don't have
to report option grants as an overhead cost, there is a price: When
employees exercise their options, companies must either buy shares in the
market or issue new stock, diluting the value of existing shares. The more
options, the greater the dilution of per-share earnings and the greater the
downward pressure on the stock price. To prevent dilution, companies such as
Microsoft regularly buy back shares. But that can be costly, too, since they
have to pay whatever the market price is at the moment.
It all adds up. Using the footnotes disclosing the impact of options
obligations upon earnings per share found in Securities & Exchange
Commission filings, the Bear Stearns team compared reported earnings to what
earnings would have been if the cost of options had been included. The
results: Earnings at S&P 500 companies would have been a ''material'' 4%
lower in 1998 if they had included stock options as a labor cost, says Pegg.
In 1997, they would have been 3% lower than reported.
Not surprisingly, the bigger the options grant, the bigger the impact on
earnings. For example, profits at computer-networking companies would have
been 20% lower if stock options were on the books. Semiconductor equipment
makers' earnings would have been 18% lower (chart). Although the Bear
Stearns report did not estimate the total value of outstanding options,
Baltimore-based accounting specialist Jack Ciesielski estimates the value of
options awarded by S&P 500 companies nearly doubled to $128.5 billion in
1998, from $65.3 billion in 1996.
Faced with the tightest labor market in a generation and a long-running
economic expansion, the increasing use of options to lure hard-to-get
workers seems like a no-brainer. And, says Diane Lerner, a senior consultant
in the compensation practice of Watson Wyatt, the dilution of earnings is an
acceptable price--and a smart long-term investment: ''Keeping key talent
improves overall productivity, which leads to a better performance.''
But what will happen if stock prices sag and options no longer pay so well?
''If we go into a bear market, companies may have to rethink this,'' says
Peter T. Chingos, head of the executive compensation practice at
compensation consultant William M. Mercer Cos. Rethinking options programs
may mean going back to offering even higher salaries, which do show up on
corporate balance sheets. On the other hand, employee demands for higher
compensation during a slow economy will also sag.
By Laura Cohn in Washington
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