The increase can be partly attributed to 2000’s weak stock market – which led to fewer options being exercised, despite employers granting them at a constant rate.
Despite the rising average overhang, more than half the companies studied reduced their overhang during 2000, but did not do so by enough to offset the amount by which other employers increased overhang levels.
Stock option overhang refers to the number of stock options granted added to those still to be granted as a percentage of a company’s total shares outstanding.
Employees are granted stock options as an incentive or as part of overall compensation, however, shareholders harbor concerns that the number of options granted will dilute the value of the shares that they hold.
According to research by Watson Wyatt, there is an optimal level – which varies by industry – where the incentive and dilution effects are balanced for maximum benefits to both employees and shareholders.
The research shows that achieving optimal overhang is important during both bull and bear markets. In 2000
- technology firms with near optimal overhang levels of 26% in 2000 returned a negative 1.7% to shareholders,
- while firms with high overhang levels of over 29% lost nearly 40% of their value in 2000, and
- those with low overhang levels lost 19.7%
In the health care address:
- firms with optimal overhang levels of 15.3% gained 58.2% for shareholders,
- while those with high overhang levels of 26.3% gained 48.3%, and
- those with low overhang levels of below 12% gained 53.2%
The study, Managing Stock Option Overhang in Today’s Economy, is based on publicly available data from 980 companies in the S&P 1500.