Stock Option Costs And Accountability

The direct cost to shareholders of stock optionand Oracle, 16%.10 These cost effects extend
compensation is the dilution of their ownershipfor many years, depending on the life of the
interest. A common managerial response to theoptions. At many companies, options have a life
dilution is to buy back outstanding shares. Theof five years. Increasingly, companies extend their
trouble with that solution is that it devourslives to as long as 10 and 15 years.
corporate funds that might be more profitablyAccountability
deployed. Shocking indirect costs are accountingLegal rules are ill equipped to police executive
rules that fail to require employee stock optionscompensation. The general stance of U.S. courts is
to be recorded as an expense on the incometo evaluate compensation issues, if at all, under a
statement. This translates into earnings per sharewaste standard. This standard rarely upsets
figures that overstate actual earnings forcorporate decisions. Waste requires pretty much
companies with executive stock optionsthe irrational trashing of corporate assets in ways
outstanding. Even the diluted earnings per shareakin to dumping truckloads of cash into the
figure does not reflect these costs.Hudson River. In the case of executive
Accordingly, you must adjust earnings figures forcompensation, U.S. courts are quite deferential to
the cost of options. Doing this is not easy,management indeed.
however, for not all information is necessarilyAs for securities disclosure laws, the SEC requires
found in the financial statements. You need tosubstantial and focused disclosure of top
examine the footnotes for something calledexecutive compensation in comparative
overhang, which is the percentage of theperformance charts. Nevertheless, corporations
company that outstanding stock options wouldcontinue to structure executive compensation
represent if they were exercised. The averagepackages so that they don't show up in the
percentage has mushroomed from under 10% abottom-line numbers. For example, after
few years ago to nearly 15% now.accounting standard setters ruled that a reduction
Still, the actual cost of options is not presentedin the exercise price of a previously issued option
directly, though there is some footnote disclosurehad to be recorded as an expense on the income
about this. The real cost equals the price at thestatement, many companies chose instead to
time of exercise minus the amount the executiveextend the life of the option.
pays (the exercise price). This is the truestWithout effective legal or accounting regulations,
measure of cost because the company couldthe chief job of policing executive compensation
have generated that much by selling the optionedlies with the corporate board. Board members
shares to others at the prevalent price instead ofmust insist that executive compensation peg
at the option price. The cost of executive stockindividual contributions to corporate performance.
options is substantial, averaging about 5% ofMeasuring executive performance by business
annual earnings among S&P 500 companies and inprofitability is the most definitive yardstick with
some cases amounting to half of reportedregard to shareholder as well as labor interests.
earnings, including at Yahoo!, Polaroid, and Palm.9 InWhen measuring performance, companies should
less dramatic but still striking examples, if stockreduce earnings by the capital employed in the
options were recorded as a cost, the 1999relevant business or by the earnings the firm
earnings of some major companies would beretains.
slashed: Cisco, 24%; Microsoft, 12%; IBM, 8%;