Stock Options Regaining Value as Incentive Tool

Employee stock options are yielding jackpots again, reenergizing high-tech workers who have been able to cash in on the recent run-up in their companies’ stocks.

The revival is vindicating stock options as an employee incentive tool -- and heartening people like David Hughes.

Hughes, 34, took a big chance when he left a secure job at the Boston Consulting Group in 1999 and took a pay cut to join Internet service provider NetZero. The move made sense at the time because NetZero granted him options on its then-hot stock.

But everything changed when NetZero’s stock began to sink in the dot-com plunge of 2000. Hughes’ stock options became worthless.

Things began to change last year after NetZero merged with a rival, Juno, to form United Online Inc., headquartered in Westlake Village. The company’s stock, worth as little as a split-adjusted $2.16 a share in late 2001, has been soaring this year, reaching a high of $43.64.

Hughes, now United Online’s senior vice president of corporate development, has been periodically exercising some of the options as United Online’s stock has climbed.

He won’t say how much money he’s made, but Hughes allows that it’s been enough to pay off all the substantial debts he piled up in college.

Although companies such as Microsoft Corp. have abandoned stock options, thousands of businesses embrace them as an inexpensive way to motivate workers, with Silicon Valley serving as ground zero for the concept.

Options give employees the chance to buy company stock at a fixed cost, known as the exercise price. Options become valuable as a stock rises above the exercise price, but they remain worthless as long as the stock trades below that price. That was common as tech stocks plummeted in recent years.

But many stock options have been regaining their value this year, with the tech-laden Nasdaq composite index climbing 38% in the six months after Baghdad was seized by U.S. troops.

“It should come as no surprise that employees are trying to get some cash out of the stock market after a long dry spell,” said Sung Won Sohn, chief economist for Wells Fargo Bank.

If it continues, the trend could provide relief for financially squeezed states such as California, where Gov.-elect Arnold Schwarzenegger faces a multibillion-dollar budget deficit.

A stock option renaissance that enriches a cross-section of workers also might provide more support for high-tech leaders as they fight proposed accounting changes that would require companies to expense the options.

Those industry leaders say stock options generate tremendous benefits that will be imperiled if the expensing reforms being considered by the nation’s accounting standards board are mandated.

A recent survey of 175 high-tech firms by accounting giant Deloitte & Touche found that nearly three-fourths of the companies plan to curtail future option awards in anticipation of new expensing rules.

From investors’ perspective, the flurry of inside stock sales isn’t a good sign. That’s because a wave of employee sales often signals the internal belief that a stock has peaked.

In the third quarter, top executives in all industries sold $36 worth of their companies’ stocks, including options, for every $1 purchased, the highest ratio in at least a decade, according to research firm Thomson Financial.

Much of the selling has been concentrated in high tech, where insiders sold $155.37 of stock for every $1 purchased in September, the highest level in seven years, Thomson Financial said.

Pinpointing just how many high-tech workers have been reaping gains from their stock options is difficult because only top-ranking executives and board directors are required to publicly disclose their transactions.

But an Associated Press sampling of the insider activity at Internet companies with hot stocks indicates large option windfalls are back in vogue. For example, executives and directors at United Online, Yahoo Inc. and Ask Jeeves Inc. realized combined gains of $55 million in the third quarter alone.

The tax deductions that companies recognize from their employees’ stock option gains provide another indication of the surge in option activity. Through the first nine months of this year, Yahoo’s tax benefits from stock option gains totaled $85.8 million, up from $38.4 million at the same time last year and just $6.1 million two years ago.

The recent gains have helped reinvigorate Yahoo, said Chief Executive Terry Semel, who reaped $25.7 million by exercising 1 million options in the last three months.

“There is no doubt the employees’ state of mind is much improved from a couple years ago,” Semel said. “There are a lot of people around here feeling a lot more excited and working hard to do an even better job.”