With Expensing Comes A Loss of Options for Most

October 24, 2003 (PLANSPONSOR.com) - If stock option expensing becomes mandatory, two-thirds of companies will reduce their long-term incentive (LTI) grants to salaried individual contributors and hourly workers.

And once the incentive is gone, indications are that it is not coming back. Over half (54%) of the companies that expect a cutback in LTI grants will occur in response to option expensing indicated that no “make-up” will be provided for the lost opportunity, according to Mellon’s Human Resources & Investor Solutions’ survey SFAS 123 – Responding to Mandatory Option Expensing.

Of those companies that do plan on making up the difference, the most popular action planned was to increase annual incentives (34%), followed by 8% of the companies each electing an increase in base salary, retirement benefits, and other means.

This does not mean that these programs – including stock options – would be abandoned altogether. Virtually all (99%) of the companies responding said they would continue to grant stock options, with grants for the most part concentrated on the top, as over two-thirds will maintain historic grant levels for Vice Presidents and executive officers.

Change is already in the air for LTIs at some companies, mostly notably among companies that have reduced the eligibility (21%), participation (31%) and overall amount delivered (37%) during the past 12 months. However, the vast majority reports no changes during this time in each altered area (78%, 68%, 57%, respectively).

Other Consequences

Also caught in the SFAS 123 fray are employee stock purchase programs (ESPP), which could see their effectiveness limited if not eliminated.Under SFAS 123 accounting treatment, ESPPs are allowed only a maximum 5% discount off the fair market value of the company stock at the end of the withholding period in order to avoid accounting charges. This differs from the 15% discount off the lower of the prices at either the beginning or end of the withholding period allowable under current accounting rules. In other words, the allowed discount is smaller and there is no “lookback” feature. The full impact of the possible accounting changes could have a devastating impact on the face of equity-based compensation. A large majority (72%) of all companies offer an ESPP, with these programs most prevalent in high technology companies (85%).

Those companies with a stock purchase plan in place. though. are still undecided about how they intend to handle the possibility of SFAS 123 expensing pressure. Almost equal were the number of companies that intend to decrease the discount to 5% to comply with SFAS 123 (48%) and those maintaining a 15% discount and accruing the associated accounting charges (45%). Only 7% plan on eliminating the plan altogether.

For those lamenting the potential demise of their ESPP though,the treatment of ESPP programs under SFAS 123 may not be a closed issue. Mellon points to a September article in the Wall Street Journalthathighlights the “unintended consequence” of stock option expensing on ESPP programs and reminds its readers that FASB may be open to providing a carve-out for these broad-based employee programs when it meets later this year as reason for hope.

Employees will not be left in the dark though, no matter what the outcome not only on the treatment of ESPPs but all compensation programs. The vast majority (92%) of all respondents plan to provide some form of communication to employees regarding any changes to accounting standards that may have an impact on these programs. Topping the list across all organizational types for the preferred method was a letter from the chief executive officer (CEO) (65%), followed by:

  • Live presentations (54%)
  • Internet/intranet presentation (38%)
  • Other (15%)
  • Newsletters (12%)

Only 8% plan on not communicating any SFAS 123 impact.

The survey polled 167 companies, 48% of which were in high technology, 33%general industry and 19% were life sciences. Invitations to participant in the survey were sent out on July 30, 2003 to 1,600 companies. More information is available through Rene Oliver Macapinlac with Mellon’sHuman Resources & Investor Solutionsat(212) 330-1121ormacapinlac.r@mellon.com.