The firm announced Tuesday that it plans to end its employee stock option program and begin awarding its 50,000 employees actual shares of Microsoft stock.   The change in approach, part of a major overhaul of the company’s compensation scheme, will begin in September. At that time, all Microsoft employees will become eligible to receive awards of restricted shares, which vest over a five-year period and gradually transfer ownership of the stock to them, according to the Wall Street Journal.

Underwater Breathing Room?

Microsoft officials say the change largely reflects the fact that many employees who have joined the company in recent years hold options with strike prices that are above the current value of Microsoft’s shares, rendering them worthless.     

As part of the new plan, Microsoft hopes to help employees get something out of the currently worthless (or “underwater”) options by selling them to a financial institution. Under that plan, which would be voluntary, employees would receive cash from that sale that reflects the strike price of their options and Microsoft’s current share price.

While not providing a precise formula for valuing the “underwater” options, it offered the following example:   If Microsoft’s shares were trading at $25, options with an exercise price ranging from $33 to $34 are expected to be sold for about $1.80 to $2.10 each, the company said, according to the WSJ.

Compensation Philosophy

“Our compensation philosophy is simple,” President Steve Ballmer said, according to an Associated Press report. “We want to be a magnet for the best people by paying smarter. We want to attract and retain employees by offering real ownership and great long-term financial incentives.   And we want to ensure that our senior employees’ total compensation is even more closely linked to growth in the number and satisfaction of our customers.”

The firm says it will record an expense for the restricted stock in its future financial statements, and will also go back and restate past earnings to reflect the cost of all equity-based compensation, including options. The company had no immediate estimate of the effect of the plan on its income statement, but previous estimates of the cost of expensing its options suggest that for the fiscal year ended in June 2002, its net income would have been $5.35 billion — nearly 32% less than the $7.83 billion it reported, or down by more than $2.74 billion.

The US Securities and Exchange Commission must approve the option-sale program.