Many Companies Exhausting Available Option Grant Shares

February 10, 2004 ( - There is a good reason why many companies are slashing their stock option programs: they're running out of shares to include in grants, a new survey found.

Two-thirds (67%) of the 165 Standard & Poor’s 500 companies questioned will exhaust available shares within 24 months, a ccording to the Deloitte & Touche LLP survey. As a result, companies will need to get investor approval to issue more shares this spring when most publicly held businesses hold their annual meetings, or at the same time next year. If they do take it to the shareholders, many companies will be disappointed, since leading institutional investors such as The Vanguard Group and TIAA-CREF are increasingly voting against such proposals because of stock dilution concerns, Deloitte said.

So, despite a bullish stock market, three-quarters of the respondents say they are planning to shift away from stock options, with nearly a third (29%) already having made cuts in the most recent grant cycle. Seventeen percent have eliminated stock options altogether.

Middle managers and rank-and-file employees are seeing the biggest option rollbacks. While one-third of respondents are making across-the-board cuts, 48% are limiting option grants to those in the executive suite. More than half (51%) will no longer make option grants to exempt employees, while 54% will no longer issue options to non-exempt workers.

“The growing gap between rising executive compensation and employee pay is a serious threat to morale and employee loyalty, and therefore, to corporate performance,” said Michael Kesner, Deloitte principal and leader of the executive compensation practice in Chicago, in a statement. “As employers overhaul their compensation programs to reduce or remove stock options, they should strive to develop incentives that reward outstanding performers at all levels of the company.”

Considering Alternatives

To replace stock options, respondents are considering a wide range of alternatives, including cash, restricted stock, phantom stock, and stock appreciation rights (SARs), according to the survey. They also are pondering other financial measures in addition to stock appreciation in gauging and rewarding performance. The top alternatives include earnings before interest, taxes, depreciation and amortization (EBITDA), net income growth’ return on capital employed, and return on equity. A smaller number of companies are considering such measures as economic valued added, market share growth, and innovative product development.

Among the possible stock incentives, Deloitte said SARs may best meet the higher hurdles more investors are setting before agreeing to issue additional shares for compensation plans, notes Kesner. “Because the requirement to expense stock options removes their accounting advantage, SARs do a better job of rewarding stock appreciation while requiring fewer company shares for awards, thereby limiting dilution,” Kesner said in a statement. “And, SARs are cheaper and easier for employees to exercise because they don’t require employees first to buy stock and then sell it, paying a commission, to realize any gains.”

Deloitte surveyed senior human resources executives from 165 Standard & Poor’s 500 companies with median revenues of $2 billion and an average of 8,000 employees. Respondents represented all industries, with 28% in manufacturing and 12% in financial services.