If shares of eBay ( EBAY) are a good thing, then managers of the sexiest company on the Internet may be getting too much of a good thing.

Over the past three years, eBay has been one of the most generous givers of options, even among technology companies known for their open-handed option allocations. And while there's no sign yet that eBay investors are concerned about the company's option grants -- eBay shares hit a new 52-week high Tuesday and closed up $3.61, or 3.6%, at $103.05 -- shareholders' equity is diluted when options are granted. And if regulators prevail with a plan to force companies to treat stock options as a regular cost of doing business, the price of options would become even more direct.

At the end of last year, there were 1.2 shares in unexercised stock options for every 10 eBay shares outstanding. At Tuesday's market capitalization, that means options on eBay shares (vested and unvested) worth nearly $4 billion are held by company employees.

There's more. At its annual meeting next month, the thriving online auction company will ask shareholders to approve a greater-than-50% increase in the number of shares it can award under its current stock-option plan. If approved, the measure would mark the third-straight year that eBay has increased its pool of options, a fact that is starting to raise the eyebrows of investor advocates.

"It sounds like they haven't transitioned to the new day in executive pay very well," said Scott Klinger, co-director of the advocacy group Responsible Wealth.

Already a prolific dispenser of options, eBay has increased its largesse even as other tech firms are reining in the practice.

eBay representatives did not return calls seeking comment on the company's stock-option proposal. But in the company's proxy statement, filed earlier this month, eBay's board urged shareholders to approve the measure, saying that stock options assist in attracting and retaining employees.

But outside analysts are more skeptical of the company's motives.

"Options are the dirty secret of corporate America," said one portfolio manager, who asked not to be named. The manager holds no position in eBay.

"The inner circle at a company benefits disproportionately, while diluting the hell out of shareholders who have not taken an active role in reining in excesses.

"But who's going to really complain, given what the stock has done," the manager continued. "And that's the problem. The stock would have done this if these guys had gotten paid one-fourth of what they've gotten."

Last year, eBay executives received 5% of the total options granted by the company. That was a significantly higher portion than executives at Cisco ( CSCO), Intel ( INTC) and Amazon.com ( AMZN).

Options' Bad Rep

The corporate scandals over the last two years have brought stock options into the spotlight. The excesses seen at companies such as Enron, WorldCom and others have been blamed in part on the incentive that options give executives to do whatever they can to boost short-term share prices.

But stock options also have gotten a bad rap because of the way they are treated under accounting rules. Although many critics argue that options are an expense that should show up on income statements, companies such as eBay have been able to keep them off their earnings reports, merely having to footnote them in their filings with the Securities and Exchange Commission.

Because companies don't have to show how much options are costing them, many have been granting excessive amounts of options, severely diluting shareholder value, critics charge. That also puts pressure on companies to continually buy back their own shares rather than return the money to shareholders in the form of dividends.

eBay, for instance, has made a name for itself as one of the few consistently profitable Internet companies. But its track record wouldn't look so good if it had to treat options as an expense.

Rather, the company would have posted three-straight years of losses from 1999 through 2001, including a whopping $117.99 million, or 44-cents-a-share loss, in 2001. Last year the company would have been in the black, although not by as much as it reported. Instead of a profit of $249.5 million, or 85 cents a share, eBay would have posted a profit of $62.9 million, or 21 cents a share.

That difference between eBay's reported earnings per share and what it would have reported if it had to take options into account is the result of eBay being one of the more prolific dispensers of options.

In 2002, for instance, eBay's net option grant, which represents the total options granted minus canceled or terminated options, was 11.8 million options, or more than 4% of the company's outstanding stock. In contrast, fellow Internet leader Yahoo!'s net option grant amounted to about 2.25% of outstanding shares last year. Meanwhile, Amazon.com actually had a negative net option grant last year, as its total number of canceled shares was about four times larger than its gross grants.

At the end of 2002, the unexercised stock options held by eBay employees and executives equaled about 12% of the company's outstanding shares. That number was higher than rival Amazon.com, where unexercised options equated to about 11% of outstanding shares.


Taken for Granted: eBay's Options Loom Large Among Fellow Tech Firms
Options grants in 2002 (numbers in thousands)
Granted Canceled Net grant Outstanding shares (end of prior year) Net grant as % of outstanding shares
eBay 16,866 5,023 11,843 277,259 4.27%
Intel 173,600 45,300 128,300 6,690,000 1.92
Cisco 282,000 82,000 200,000 7,324,000 2.73
Yahoo! 32,566 19,630 12,936 575,520 2.25
Siebel 5,887 56,967 (51,080) 466,950 -10.94
Amazon 3,045 12,262 (9,217) 373,218 -2.47
Notes: Siebel bought back 28 million options in 2002, mostly from CEO Tom Siebel. Cisco's fiscal year ends in July.

As a fraction of outstanding shares, other tech companies have larger pools of unexercised options. Because of the increase in its share price, however, the average option at eBay is in the money -- which is not the case with many tech companies. The average price of an unexercised option at eBay at the end of 2002 was $53.73; the company's stock closed at $103.05 on Tuesday. In contrast, the average price of an unexercised Siebel ( SEBL) option at the end of last year was $17.42; Siebel's stock closed at $9.17 Tuesday.

That higher price means more of the options are being exercised, diluting the stock further. Options equal to 3.5% of eBay's outstanding shares (as of the beginning of 2002) were exercised last year, a higher proportion than at Yahoo!, Siebel, Intel and Cisco.

Also, a number of these companies have taken steps to rein in their options grants. Yahoo! has promised shareholders that it will hold future grants to 2% or less of outstanding shares in any one year. Intel has a similar policy. Meanwhile, earlier this year Siebel founder Thomas Siebel agreed to cancel all of the options he had been granted since 1998.

Thus far, eBay has taken no similar steps.

Instead, eBay wants to increase the number of shares it has available to grant. The additional shares represent more than 4% of the company's outstanding stock. Meanwhile, shareholders already approved increases in the company's pool of options by 7% and 4% of outstanding shares in 2002 and 2001, respectively.

Investors don't typically complain about option-grant increases that amount to 5% or less of shares, said Klinger of Responsible Wealth. But those grants are usually spread over more than one year, meaning an effective rate of 2.5% or less, he said.

A reckoning soon may be at hand, however. The Financial Accounting Standards Board has taken up the issue of stock options and is expected to come up with a proposal later this year that would require all companies to treat options as an expense.

Currently, companies can choose whether or not to expense options. Although some prominent corporations such as the Washington Post and Coca-Cola have said they will expense options, others, including many technology companies, have resisted the motion. A final rule is expected next spring.

Meanwhile, investors already are scrutinizing eBay's option practices. Last year, Institutional Shareholder Services came out against the company's proposed option-grant increase, citing their dilutive effect and the fact that the company could reprice underwater options without shareholder approval.

ISS has not yet staked out a position on this year's proposal. But don't be surprised if some prominent investors or advocates come out against it.

"I think (these types of plans) are being scrutinized much more carefully," said Ann Yerger, director of research at the Council of Institutional Investors. "People are looking at these with a much harder eye."

A Thing of the Past

Part of that comes from the issue of dilution and the focus on corporate scandals. But it also comes as some of the traditional rationales for options are losing weight, especially at eBay.

Options defenders have typically defended their use as a way for cash-poor start-up companies to attract talented workers. Often not able to offer competitive salaries, such companies have granted options as a way to offer the possibility of long-term rewards to workers.

But eBay is anything but a cash-poor company. At the end of the first quarter, eBay was sitting on $1.55 billion in cash and cash equivalents, up from $1.11 billion at the end of 2002.

Meanwhile, unemployment has skyrocketed in Silicon Valley as struggling technology companies have laid off thousands of workers. Unemployment in Santa Clara County, Calif., where eBay is based, now stands at 8.3%. The unemployment rate during the height of the technology boom was less than 2%.

With unemployment so high, investors might rightly wonder why eBay needs to continue dispensing so many options each year to attract and retain workers, said newsletter writer and compensation critic Graef "Bud" Crystal.

"Why is it when there's blood all over the streets in Silicon Valley and you've got Ph.D's in computer science who will work for food, why is it that these rates are not coming down faster? The whole pay structure should be coming down," Crystal said.

Crystal suggests that eBay executives may be trying to get the option-grant increase approved before FASB rules that companies have to expense options. Once FASB's rule goes into place, the whole option game may be up, he said.

"This could be the last chance for gas before the bridge," Crystal said.