| The direct cost to shareholders of stock | | | | 16%.10 These cost effects extend for many |
| option compensation is the dilution of their | | | | years, depending on the life of the options. |
| ownership interest. A common managerial | | | | At many companies, options have a life of |
| response to the dilution is to buy back | | | | five years. Increasingly, companies extend |
| outstanding shares. The trouble with that | | | | their lives to as long as 10 and 15 years. |
| solution is that it devours corporate funds | | | | |
| that might be more profitably deployed. | | | | Accountability |
| Shocking indirect costs are accounting rules | | | | |
| that fail to require employee stock options | | | | Legal rules are ill equipped to police |
| to be recorded as an expense on the income | | | | executive compensation. The general stance of |
| statement. This translates into earnings per | | | | U.S. courts is to evaluate compensation |
| share figures that overstate actual earnings | | | | issues, if at all, under a waste standard. |
| for companies with executive stock options | | | | This standard rarely upsets corporate |
| outstanding. Even the diluted earnings per | | | | decisions. Waste requires pretty much the |
| share figure does not reflect these costs. | | | | irrational trashing of corporate assets in |
| | | | ways akin to dumping truckloads of cash into |
| Accordingly, you must adjust earnings figures | | | | the Hudson River. In the case of executive |
| for the cost of options. Doing this is not | | | | compensation, U.S. courts are quite |
| easy, however, for not all information is | | | | deferential to management indeed. |
| necessarily found in the financial | | | | |
| statements. You need to examine the footnotes | | | | As for securities disclosure laws, the SEC |
| for something called overhang, which is the | | | | requires substantial and focused disclosure |
| percentage of the company that outstanding | | | | of top executive compensation in comparative |
| stock options would represent if they were | | | | performance charts. Nevertheless, |
| exercised. The average percentage has | | | | corporations continue to structure executive |
| mushroomed from under 10% a few years ago to | | | | compensation packages so that they don't show |
| nearly 15% now. | | | | up in the bottom-line numbers. For example, |
| | | | after accounting standard setters ruled that |
| Still, the actual cost of options is not | | | | a reduction in the exercise price of a |
| presented directly, though there is some | | | | previously issued option had to be recorded |
| footnote disclosure about this. The real cost | | | | as an expense on the income statement, many |
| equals the price at the time of exercise | | | | companies chose instead to extend the life of |
| minus the amount the executive pays (the | | | | the option. |
| exercise price). This is the truest measure | | | | |
| of cost because the company could have | | | | Without effective legal or accounting |
| generated that much by selling the optioned | | | | regulations, the chief job of policing |
| shares to others at the prevalent price | | | | executive compensation lies with the |
| instead of at the option price. The cost of | | | | corporate board. Board members must insist |
| executive stock options is substantial, | | | | that executive compensation peg individual |
| averaging about 5% of annual earnings among | | | | contributions to corporate performance. |
| S&P 500 companies and in some cases amounting | | | | Measuring executive performance by business |
| to half of reported earnings, including at | | | | profitability is the most definitive |
| Yahoo!, Polaroid, and Palm.9 In less dramatic | | | | yardstick with regard to shareholder as well |
| but still striking examples, if stock options | | | | as labor interests. When measuring |
| were recorded as a cost, the 1999 earnings of | | | | performance, companies should reduce earnings |
| some major companies would be slashed: Cisco, | | | | by the capital employed in the relevant |
| 24%; Microsoft, 12%; IBM, 8%; and Oracle, | | | | business or by the earnings the firm retains. |