Flooding the Market– Stock Options Getting More Expensive – Hewitt

May 31, 2000 (PLANSPONSOR.com) - Stock options, long considered a relatively cheap way to retain employees in a tight labor market, are getting more expensive - and employers that have placed those programs on "auto-pilot" might want to reconsider their "options", according to a new survey by consulting firm Hewitt Associates.

The cost of offering stock options has been steadily increasing over the last three years, Hewitt said Wednesday.

Its study of 63 Fortune 100 US companies showed that the cost of options (as measured through potential dilution) has gone up 2% in the last three years. Although 52% of companies expressed a moderate (48%) or high (13%) level of concern over the cost, few are taking major steps to lower or control costs.

“The strong earnings and stock price performance in recent years has allowed companies to put the issue of stock option cost on the back burner,” said Ryan Harvey, executive compensation consultant at Hewitt. “If we have a market correction, or if earnings and stock price decline, many shareholders could become more concerned about the whole stock option cost issue, and pressure boards to do something about it.”

Over half of the companies (52%) surveyed don’t lower the number of options granted to compensate for an increase in grant value when stock price increases. Similarly, nearly 50% of companies target stock option levels above the 50th percentile in response to the competitive market for talent. “Companies need to be careful of these practices because they can lead to inflation of award sizes over time in a growing market,” said Harvey.

Forty-two percent of companies said that they expect the overall size of their stock option grants to rise over the next three years. Vesting schedules varied from one to five years, with 45% of companies vesting options over three years, and 26% vesting over four years. The study showed a modest trend toward increasing vesting schedules to four years, in order to more effectively retain talent.