Microsoft’s Option Grants May Signal Trend for Tech Firms

In an action sure to reverberate through the high-technology world, software giant Microsoft on Tuesday granted new stock options to all 34,000 full-time employees, aiming to compensate them for the stock’s 40% dive this year.

Other firms hit by the sudden tech-stock bear market have been mulling similar steps as a way to head off defections of workers for whom options form a big part of their pay package.

Analysts said Microsoft’s move may increase pressure on other tech companies to act. But the move also may provoke an angry reaction from shareholders. “Nobody’s doing anything to offset their losses,” said Jon Holman, a high-tech executive recruiter in San Francisco, referring to nonemployee shareholders of Microsoft.

Microsoft President Steven Ballmer told employees that they would immediately receive options equal to the number they were awarded in July in their regular annual review, according to spokesman Dan Leach. Employees hired since July also will receive options matching the number they were awarded upon hiring, he said.

The announcement came one day after Microsoft’s shares plunged 16% in the wake of the company’s downbeat sales forecast Thursday, and on reports that the government may seek to have Microsoft broken into two firms.

The new options allow employees to purchase Microsoft shares at Monday’s close of $66.63. The stock was trading above $90 for most of July, when the bulk of the 1999 options were granted.

Like other Microsoft options, the new ones don’t begin to take effect until a year after the award. After one year, one-eighth of the options can be exercised, followed by another one-eighth every six months.

About 70 million new options are being granted under the program, Leach said.

Microsoft said there won’t be any impact on the company’s earnings. By creating more shares for employees via options that could eventually be exercised, companies can dilute per-share earnings for other shareholders. However, some companies minimize dilution by repurchasing shares in the open market even as they grant new options.

Critics have long assailed Microsoft and other companies for declining to treat stock options as an expense, like salaries, in their financial reporting. Were options booked as an expense, many high-tech firms would see their profits reduced significantly or even wiped out, critics say.

Options are, of course, a quick way for employees to get rich when share prices are doubling or tripling, as was the case with many tech stocks early in the year. But in a prolonged stock downturn, options may become far less useful as a hiring inducement or motivator for current employees.

In the case of Microsoft’s new grants, “Those options are going to have a ‘handcuff’ effect [on employees] only if they perceive that the stock is going to go up from $66,” Holman noted.

“New options don’t count for much if you don’t believe in where the company is going or in the business plan,” he added.

With its new grants, Microsoft avoided a more controversial practice: repricing existing options to lower the “strike price” at which they can be exercised. That has become more common when the market prices of tech companies’ shares have slumped. And it may be the only alternative for many firms whose employee stock options now are under water, if the companies would risk too much dilution of earnings by simply issuing more options to workers, or if shareholders haven’t authorized additional options.

“Investors hate [option repricing],” said Richard Carlson, an economist with Spectrum Economics in Palo Alto.

A key purpose of options is to keep employees focused on boosting their company’s profitability, he noted. If repricing of options lets the employee win even if the share price falls, “it’s not a very impressive incentive plan,” he said.

Companies that reprice options typically argue that it’s necessary to retain employees whose options have fallen below the original strike price, and are therefore worthless. Shareholders, they argue, may suffer in the long term if valued employees bolt for competitors or for new careers.

“I don’t think the tech [companies] have much choice,” said USC business professor Edward Lawler. “They have to do something to get compensation in the hands of people--it’s either cash [which such companies don’t generally have] or by repricing options.”

However, accounting rule makers have begun cracking down.

The Financial Accounting Standards Board last month issued new rules--effective July 1-- requiring companies to incur a charge against earnings when they reprice options.

Brian Hall, professor at Harvard’s business school, argued that Microsoft’s regime of annual options awards is preferable to the “upfront mega-grants” that have become a common hiring bonus among tech firms.

The big upfront grants are risky because if the stock falls, the options go bad all at once, increasing the temptation to reprice, Hall said.

Although Microsoft’s award of new grants also transfers value from the company to employees, it is more incremental than a broad repricing, Hall said.