Microsoft Abandons Stock Options
Software giant Microsoft Corp. said Tuesday that it would no longer give employees stock options, abandoning a compensation system that came to symbolize the go-go economy of the 1990s -- and the excesses that critics say helped fuel the dot-com bubble and a rash of corporate financial scandals.
The company said it would shift in September to awarding employees outright grants of stock instead of options. And in a move addressing a raging controversy over corporate accounting, Microsoft said it would begin to formally count all stock-related compensation as a cost of doing business.
The changes will “better align” the interests of employees and shareholders, Microsoft Chief Executive Steve Ballmer said.
They also are likely to further ramp up the debates over the merits of options and whether companies deceive investors with their accounting of the programs’ costs.
Microsoft’s move is emblematic of the post-bubble era in the technology sector, where the emphasis now is on accountability, transparency and slower, more sustainable growth, some experts said.
“It’s a sign of a new era,” said John Challenger, chief executive of Chicago-based consulting firm Challenger, Gray & Christmas Inc. The shoot-the-moon mentality of the 1990s has given way to a realization that companies must be more realistic in their growth expectations and more responsive to shareholders’ concerns, he said.
Stock options -- rights to buy shares in the future, often at a bargain price -- soared in popularity in the 1990s as a way for companies to reward workers with sums that frequently dwarfed their salaries. The tech sector, centered in Silicon Valley, became synonymous with vast options-generated wealth.
The rise of options coincided with, and egged on, the great bull market of that era, which lifted the stock market to unprecedented heights. The awards were widely viewed as a cheap way for companies to attract star CEOs and keep valued employees happy and productive.
The number of employees holding options increased tenfold from 1992 to 2002, according to the Employment Policy Foundation in Washington, which estimated that 3 million workers received options awards last year.
At Microsoft, all 55,000 full-time employees receive options, the company said. From 1986 to 1992 about 2,000 of the Redmond, Wash.-based firm’s employees became millionaires thanks to their options, according to a study by the Cato Institute think tank.
But as options awards have grown in scope and size, so has criticism that many companies were abusing the system to excessively reward a relative few executives and key employees at shareholders’ expense.
The stock market’s plunge from 2000 through 2002 deepened the debate as millions of average shareholders lost gigantic sums while many executives still managed to cash in options at handsome profits.
Last year, the controversy was inflamed anew by revelations of massive accounting scandals at companies including Enron Corp. and WorldCom Inc. Many investors questioned whether extraordinary options grants to executives had encouraged fraudulent bookkeeping designed to inflate stock prices and mask financial woes.
One of the big selling points of options was that they provided a terrific incentive for getting managers to focus on what matters most to many shareholders -- a rising stock price. But critics say it is now clear that the incentives were out of whack.
“An option is an expectancy, not actual ownership, and that’s a big difference,” said Charles Elson, director of the University of Delaware’s Weinberg Center for Corporate Governance.
If a company underperforms and its stock price fizzles, options holders lose their potential gains but “there is no real wealth depreciation as there is for shareholders,” he said.
With no tangible downside and unlimited upside, big options awards have encouraged some executives to take imprudent business risks or even manipulate earnings numbers to jack up their stock price, Elson said.
Microsoft did not address those issues in its announcement Tuesday. The company said the shift to stock grants instead of options awards resulted from a yearlong review of its pay program and reflected “significant feedback from employees about compensation and related issues.”
CEO Ballmer said the change “will help the company continue to attract and retain the best employees, and better align their interests with those of our shareholders.”
Under the new system, all employees except Ballmer and founder Bill Gates would be eligible to receive stock grants, Microsoft said. The awards would be evenly distributed over five-year periods. For example, an employee granted 100 shares would take possession of 20 shares each year. The employee then could hold the shares or sell them.
In addition, the company said a “significant portion” of stock-based compensation for more than 600 senior employees would be based on “growth in the number and the satisfaction of Microsoft customers.” It did not elaborate on that plan.
The software titan’s move comes as the personal computer business matures and the company faces slower growth prospects, analysts said. Its stock no longer is a Wall Street star: It has traded mostly between $22 and $32 a share since the end of 2000, and closed at $27.70 on Tuesday, up 28 cents, before the announcement was made.
The price has fallen from a peak of near $60 in 1999. The stock’s stagnation means employees, especially more recent hires, no longer can count on big payoffs from previously granted options. Indeed, Microsoft said 88% of its outstanding options are “under water” -- that is, the option purchase price exceeds the current stock price.
“By doing it this way, they also do away with the problems associated with options,” said Rob Enderle, technology analyst with Cambridge, Mass.-based Forrester Research. “If you think about it, options are unfair. They compensate people based on the date they were hired. If you’re hired when the company stock is high, you don’t get much. By getting shares, it’s more fair and everybody’s in the same boat.”
Acknowledging the worthless options held by many employees, Microsoft said it is working on a plan to allow workers to realize “some value” on the options by selling them to a third-party financial institution.
For the tech industry overall, the most controversial element in Microsoft’s new program is its decision to begin formally counting all stock-based compensation, including outstanding options, as a business expense.
Under current accounting regulations, companies are required only to note the potential costs of options grants in footnotes to financial statements. Critics -- including billionaire Warren E. Buffett, a longtime friend of Bill Gates -- have charged that that allows companies to pretend that options don’t cost shareholders because they don’t require cash outlays. But there can be significant costs as companies buy their shares in the open market to fund options plans, and as options grants dilute other shareholders’ stake.
After the Enron and WorldCom scandals, political pressure has risen on accounting regulators to force companies to formally count options as an expense -- which would lower firms’ reported profit. Microsoft said expensing options would have reduced fiscal 2002 profit from $7.8 billion to $5.4 billion.
The idea is vehemently opposed by many companies in the tech sector. They say there is no simple way to value options.
“We continue to believe that mandatory expensing of all employee stock options is bad accounting and will only serve to obscure the real performance” of companies, said Rick White, chairman of the International Employee Stock Options Coalition.
Microsoft said Tuesday that it agreed “with others in our industry that there’s no one-size-fits-all approach” to accounting for stock-based compensation.
Still, analysts said its decision could put new pressure on other tech companies both to phase out options programs and to formally expense them.
Executives at San Jose-based EBay Inc. have been discussing the question of how to expense stock options, and whether to continue issuing them, for a year, company spokesman Kevin Pursglove said. Throughout the conversations, a consistent theme has been established, he said: Don’t try to fix what’s not broken.
“We continue to believe that stock options are the core of EBay’s compensation philosophy,” Pursglove said.
At Cisco Systems Inc. in San Jose, the world’s largest maker of equipment used to build networks of computers, Chief Executive John Chambers said Tuesday that “our views have not changed.”
“Broad-based employee stock option plans are vital to the growth, innovation and, indeed, the future of the tech industry and jobs in this country.”
Times staff writers Kathy M. Kristof and P.J. Huffstutter contributed to this report.
