How eBay Cashes In on Employee Options

eBay (EBAY Quote) has become known as a cash machine. But much of the cash the company has generated in recent years has come not from its thriving auction business, but from the brisk sales of stock options by its employees.

Nearly one-fifth of eBay's operating cash flow last year came from the tax benefit related to stock options. Meanwhile, the money generated from that tax benefit plus the actual cash it saw from employees selling their options was equivalent to eBay's free cash flow last year and helped swell the company's cash-on-hand position.

This options-related cash forms a large fraction of the company's overall cash flows, which are touted by analysts as an indicator of value. And the sheer amount of options being exercised at eBay raises questions about fairness to shareholders.

"The way (the company's) financial statements are presented makes it look like eBay earned four times as much as they really did (last year) and it also obscures the fact that the company's been funding operations by offering half-off bargains on sales of stock to its employees," said Gary Lutin, an investment banker and corporate-governance critic.

"It's astonishing that people can still be doing this."

eBay representatives did not return calls seeking comment about the company's options practices or the money it raised from their sale. However, company officials have said in the past that they view options as a way to attract and retain employees.

The use of options in general has drawn criticism from investors because they dilute shareholder value and their use has been linked to the scandals at Enron, Tyco and WorldCom. But little has been made of the enormous cash benefit that some companies have seen from options.

When an employee at a company exercises and sells options, the company benefits in two ways.