Options Habit Dies Hard for Tech

Microsoft's decision was persuasive, but so is the need to show rosy financial results.
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Given its size and prestige in tech,

Microsoft 's

(MSFT) - Get Report

decision to dump stock options and instead award employees with stock has been called a harbinger in the debate over the controversial compensation.

Maybe. But options holdouts have a persuasive countermotivation: The need to present a financial picture that is as positive as possible.

Microsoft may have been preparing for what some view as the inevitable: A requirement that companies expense options. But with Congress still weighing legislation to put a moratorium on such rules, other tech companies are going to resist as long as they can, especially those that would post a loss if they had to expense options, some observers predict.

"My distinct impression is that these other companies are attempting to avoid at all costs an accounting charge for their stock-based compensation," said Robert Willens, an accounting and tax analyst at Lehman Brothers.

Microsoft said Tuesday that starting in September it will begin giving employees restricted shares of stock instead of options, a move that requires the company to recognize that stock as an expense. In addition, Microsoft plans to expense previously granted stock options.

No Give at Intel

But so far, at least one vocal opponent to expensing stock options,

Intel

(INTC) - Get Report

, is sticking to its guns. The company is not planning to make any changes to its own compensation policy, following an extensive review in May, Intel spokesperson Bill Calder said.

"We still think expensing is a bad idea and will ultimately lead to less meaningful, reliable information on a particular company," says Calder. "If the problem is excessive executive compensation, expensing stock options does not solve that. Excessive executive compensation is really a problem of corporate governance and expensing doesn't solve it."

Intel has said it tends to pay executives below-average wages, but makes up the difference with cash bonuses. Over 97% of Intel's options are rewarded to rank-and-file employees, with the top five executives typically receiving less than 2% of disbursed options in a given year, Calder points out.

Still, some critics might say the problem with Intel is simply that it bestows too many options altogether. Intel's 2002 profit of $3.1 billion would have been reduced to $1.9 billion after expensing for options under the fair-value method.

In 2002 alone, Intel's net options grants amounted to 1.9% of outstanding shares. Options granted by Microsoft in its 2002 fiscal year, which ended June 30, amounted to 0.7% of outstanding shares.

To be sure, many technology and Internet companies remain recalcitrant about their use of options. eBay, for instance, secured shareholder

approval last month for a

plan to increase the number of shares available under its latest stock plan by 50%. The approval came

despite

warnings that the company was giving out an excessive amount of shareholder wealth in the form of options.

Other companies, meanwhile, are likely to resist following Microsoft's decision to expense options because that would make their earnings dry up and fall into the red.

For instance,

Veritas Software

(VRTS) - Get Report

would have reported GAAP losses of 58 cents a share in 2002,

BEA Systems

would have suffered losses of 16 cents a share in its fiscal year 2003, which ended in January, and

Mercury Interactive

(MERQ)

would have posted losses of 49 cents a share in 2002 if they had expensed options, noted RBC Capital Markets analyst Sarah Mattson in a note Wednesday. Without the expense, all companies recorded profits.

"It is hard for us to imagine that they will be anxious to follow Microsoft's lead, although we do think that the use of options is becoming less and that many are searching for alternative compensation schemes," Mattson wrote. She has an outperform rating on Microsoft and her firm hasn't done banking with the company.

Early Adopter

Yet, Microsoft's change follows a similar move by another Seattle area-based company. Last year, leading e-tailer

Amazon.com

(AMZN) - Get Report

announced that it would begin expensing options this year. At the time, the company said the move would allow it to use restricted stock and other forms of stock-based compensation to pay employees.

The company now primarily awards restricted stock and restricted stock units -- unvested shares -- to employees, said spokesman Bill Curry. In fact, outside of France, where the company faces an issue with moving away from options, Amazon has stopped giving stock-options awards, Curry said. The restricted shares that Amazon grants have four-year vesting periods, although there is some variation in how they vest, he said.

In the first quarter, Amazon granted restricted stock and restricted stock units worth $6.3 million, up from $1.4 million in the first quarter of last year. Meanwhile, the company's outstanding stock options have declined from 62.1 million shares -- equivalent to 16.6% of outstanding shares -- in the year-ago quarter to 37.6 million -- about 9.7% of outstanding shares -- at the end of the first quarter this year. The decline came from a mix of options exercises and cancellations.

Curry declined to comment on Microsoft's move to expense and limit usage of stock options. But he said the move was right for Amazon.com.

"Once you are comfortable with expensing, you have more tools to choose from," he said. "We chose restricted shares, because we believe they more closely align the interests of internal shareholders with external shareholders."

Some companies, however, are merely cutting back on the options they are doling out to employees. Well before Microsoft's announcement,

Dell Computer

(DELL) - Get Report

Chief Financial Officer Jim Schneider said the company will hand out only half as many options for fiscal year 2004 (which ends in January) as it did in the prior year. Last year, options took a hefty bite out of Dell's net income: Reported profits of $2.1 billion would have fallen to $1.4 billion after accounting for options using the Black-Scholes method.

Intel and

Yahoo!

(YHOO)

this spring both successfully fought off shareholder resolutions that would have encouraged them to expense stock options. But as a possible bone to shareholders, both pledged to limit new options awards to less than 2% of outstanding shares.

Meanwhile,

Siebel

(SEBL)

terminated millions of options over the last year, as company founder Thomas Siebel agreed to

cancel all of the 25.95 million options he'd received since 1998.

But if companies are eventually required to expense options, as the Financial Accounting Standards Board has proposed, restricted stock awards may become a more popular approach than options.

"If it becomes mandatory, then I think restricted stock would be something we'd see pretty frequently because it is clearly, from the employee's point of view, a better form of compensation," said Robert Willens, an accounting and tax analyst at Lehman Brothers. Indeed employees have become increasingly disillusioned with options as stock prices have fallen below option strike prices, rendering many options virtually worthless. "Compensation consultants would tell you get more bang for the buck morale-wise from actual stock grants," Willens added.

Microsoft has said the restricted stock awards to employees will vest over five years, with employees getting 20% of the stock each year.

Typically, with restricted stock, employees don't receive any shares until they have worked at the company until the end of the vesting period. That's different from options, which employees typically receive in equal increments each year during the vesting period. For instance, an employee with options that vest in five years typically would receive one-fifth of the total options each year. But employees awarded restricted stock with a 5-year vesting period typically would not receive any of the shares until they worked for the company five years, when they would then get all of the stock. "It's usually all or nothing," Willens said.

Staff writers K.C. Swanson and Troy Wolverton contributed to this report