Nearly three-quarters (72%) of high-tech Chief Executive Officers (CEO) and Chief Financial Officers (CFO) expect to run out of shares to grant to employees within two years. For one out of five ( 20%) the drought is expected to happen within one year, while the remain 52% see the employee stock option pool drying up between one and two years, according to the 2003 Deloitte Technology Stock Compensation Survey.
In fact, the stock option divesture has already begun. To make their options last longer, 73% of the publicly held companies have already reduced or plan to decrease the number of options they grant. Most companies are making across-the-board cuts in option grants, but 35% of the respondents plan to ration their reserves by confining the awards to executives and managers.
The apparent lack of future stock option motivation is traced back to the looming stock option expensing proposal as the financial advantage these vehicles currently enjoy could be taken away as early as next year if the Financial Accounting Standards Board (FASB), the nation’s accounting rulemaker, requires that stock options be recognized as an expense. In fact, the costs of option expensing have made the issue “public enemy Number 1 for the tech community,” said Ellie Kehmeier, deputy national tax leader for Deloitte’s Technology, Media & Telecommunications (TMT) Group and who helped oversee Deloitte’s survey of 88 privately held and 87 publicly held tech companies during July and August.
While publicly held companies are more concerned about option expensing than their privately held counterparts, both groups are adopting expense accounting at essentially the same rate. In fact, 3% of public and 5% of private companies indicate that they are currently expensing, and an additional 5% of both public and private companies say they plan to start expensing before it becomes required. This means that roughly 90% of companies are not currently expensing options, and they have no plans to do so unless required.
Not surprising then was that 80% of the public company respondents said the potential requirement to expense employee options is the top, or second most important issue impacting their equity compensation practices. Potential dilution from employee stock options ranked second in public companies’ concerns, followed by the new rules giving shareholders an increased say over equity compensation matters and underwater options – options with exercise prices greater than the current stock price.
With most tech companies (69%) distributing options to at least 90% of their employee base, a shift away from this vehicle will have a major impact on employee compensation practices. Most companies are examining alternative means of paying employees, with 63% that plan to replace options said they would grant restricted stock or restricted stock units that vest over time. Other respondents indicated that they would offer:
- stock or units that vest based on performance criteria
- a cash-based performance plan
- performance-vesting stock options.
These programs are being looked at as companies realize the value of equity based compensation practices in employee retention programs. In fact, 57% said that providing employees with a competitive pay arrangement was the most important factor in looking at alternatives.
The next-highest choice was the ability to link pay to company, business unit or team performance. “Tech companies need to be competitive and want to pay for performance, but are also worried about cash flow and earnings per share. Plain vanilla, time-vested stock options have always carried a huge advantage in that they don’t have to be expensed on the income statement. If that advantage goes away, companies will become more creative in designing compensation plans that better suit their needs,” Michael Kesner, a partner in Deloitte’s Human Capital practice, explained.