Tech Option Grants and Overhang Levels Down

June 12, 2003 ( - Workforce reductions, reduced competitive pressure for employee talent, and concerns about potential accounting charges for options have all contributed to a decline in stock option grants in 2002 among small-cap technology companies.

In fact, option grants were 25% lower in 2002 than the year prior among these companies. Further, employee forfeitures of both vested and unvested options continue to grow as layoffs and voluntary terminations still reverberate in the industry, according to a study by Presidio Pay Advisors.

However, the combination of larger forfeiture and declining option grants translates into lower annual “run-rates,” the number of options granted in a year less any cancellations divided by a company’s total shares outstanding. The rate is down to 2.3% of shares outstanding, which is 30% lower than the previous year and the lowest run-rate this industry has seen in years.

A lower run rate thus translates to companies having more shares available to grant without the need for a new stock option plan. In fact, at 2002’s run rate levels, companies are expected to have enough shares available for future grants to fund two years of option grants.

This works well for the majority (56.8%) of companies that are operating with non-shareholder approved plans and 33% that requested additional company outstanding shares become available for stock options. Further, with the anticipation of companies beginning to account for the “fair value” of stock option expenses, the survey anticipates run-rates, and another equity compensation measure stock option overhang, will continue to decrease.

Hungover on Overhang

Stock option overhang had experience a dramatic run up in the late 1990’s as companies shifted from cash-based compensation to equity-based compensation, resulting in larger and broader stock option grants.However, amendments to stock option accounting rules could signify a change that is beginning to become evident now (See FASB: Options Are An Expense At Exercise ).

The median option overhang level, the sum of shares reserved for outstanding grants plus shares available for future grants as a percentage of common shares outstanding, is now at 22.5% among the 118 companies studied. Presidio points to a stabilizing of the overhang level for now because employees are hanging on to options that are underwater or only slightly in-the-money. However, if recent grant rates continue, overhang will likely drop significantly in future years into the mid-teen range.

Additionally, companies have been looking to reduce their overhang levels in an effort to find the “sweet spot” – the optimal level at which companies financially outperform their peers. This “sweet spot” occurs at the point where the incentive and dilution effects are balanced for optimal benefits to employees and shareholders.

Presidio’s calculations for stock option overhang levels among technology companies are very close to Watson Wyatt’s earlier calculation of 24.9% (See Option Overhang Continues To Increase ). Similarly, Watson Wyatt attributes this increase to the large number of unexercised options and the trend for technology to compensate its employees more with stock options than other industries.

A full copy of the report can be found at under “Research & Tools.”