Five Common Myths About Broad-Based Equity Plans
By Corey Rosen, NCEO Executive Director
February
2005During the 1990s, according to our research here at the National
Center for Employee Ownership, the number of employees getting stock
options ballooned from less than one million at the start of the decade
to about 10 million by the end. That number has now leveled off in the
face of uncertainties over how new accounting rules will affect
shareholder reactions to options, and some companies may cut back their
plans. But we expect any such trends to be short-term. Stock options
provide employees the right to buy shares of company stock at a price
fixed today (usually the market price) for a number of years (usually
10) into the future. So if the stock price goes up, you can buy shares
at a very cheap price. The press was full of reports of "optionnaires,"
employees who struck it rich when their company's stock skyrocketed.
Then the market collapsed, and instead stories were being written about
option tax disasters, precipitous declines in morale of option-ladened
employees, and a rapid move away from compensating employees with
equity. Accounting rules were changed, causing more doubt about the
future of options. While much of the reporting on stock options was
accurate and insightful, much of it subscribed to common myths that
distorted what was happening, both during the market's rise and after
its fall. For a variety of reasons, options granted to most or all
employees (or in some companies, other forms of equity) have become an
institutionalized part of compensation at many companies. It is
important, then, to separate the myth from the reality about how these
plans work.
2005During the 1990s, according to our research here at the National
Center for Employee Ownership, the number of employees getting stock
options ballooned from less than one million at the start of the decade
to about 10 million by the end. That number has now leveled off in the
face of uncertainties over how new accounting rules will affect
shareholder reactions to options, and some companies may cut back their
plans. But we expect any such trends to be short-term. Stock options
provide employees the right to buy shares of company stock at a price
fixed today (usually the market price) for a number of years (usually
10) into the future. So if the stock price goes up, you can buy shares
at a very cheap price. The press was full of reports of "optionnaires,"
employees who struck it rich when their company's stock skyrocketed.
Then the market collapsed, and instead stories were being written about
option tax disasters, precipitous declines in morale of option-ladened
employees, and a rapid move away from compensating employees with
equity. Accounting rules were changed, causing more doubt about the
future of options. While much of the reporting on stock options was
accurate and insightful, much of it subscribed to common myths that
distorted what was happening, both during the market's rise and after
its fall. For a variety of reasons, options granted to most or all
employees (or in some companies, other forms of equity) have become an
institutionalized part of compensation at many companies. It is
important, then, to separate the myth from the reality about how these
plans work.
Myth #1: Most People Getting
Options Worked for Dot-ComsOne of the most prevalent and misleading
misperceptions was (and still is) that most employees getting options
work (or now worked) for dot-com companies, most of whom were small,
pre-IPO ventures. This was never even close to true. There were a lot
of dot-coms, to be sure, and most of them did give most or all their
employees options, but most also employed well under 100 people. The
total employment at all the pre-IPO dot-com companies never amounted to
more than a few percent of the 10 million people getting options. In
fact, almost all the employees getting options work (and worked) for
publicly traded companies, and most of these work for large employers.
Options Worked for Dot-ComsOne of the most prevalent and misleading
misperceptions was (and still is) that most employees getting options
work (or now worked) for dot-com companies, most of whom were small,
pre-IPO ventures. This was never even close to true. There were a lot
of dot-coms, to be sure, and most of them did give most or all their
employees options, but most also employed well under 100 people. The
total employment at all the pre-IPO dot-com companies never amounted to
more than a few percent of the 10 million people getting options. In
fact, almost all the employees getting options work (and worked) for
publicly traded companies, and most of these work for large employers.
Myth
2: OK, Well at Least They Worked for High-Technology CompaniesThe large
majority of high-technology companies do make most of their employees
eligible for stock options, but even the highest estimates for the
technology sector place employment at about five million. If 60% of
these get options (a reasonable guess), then only three million
employees getting options are technology workers. In fact, about 15% to
20% of all public companies give employees options, and many of these
are outside the technology sector. Many large banks provide broad
options, for instance, as do a number of large pharmaceutical
companies. Retailers like Whole Foods, Walgreens, and Starbucks give
out broad options. So do PepsiCo and Procter & Gamble.
2: OK, Well at Least They Worked for High-Technology CompaniesThe large
majority of high-technology companies do make most of their employees
eligible for stock options, but even the highest estimates for the
technology sector place employment at about five million. If 60% of
these get options (a reasonable guess), then only three million
employees getting options are technology workers. In fact, about 15% to
20% of all public companies give employees options, and many of these
are outside the technology sector. Many large banks provide broad
options, for instance, as do a number of large pharmaceutical
companies. Retailers like Whole Foods, Walgreens, and Starbucks give
out broad options. So do PepsiCo and Procter & Gamble.
Myth
#3: Most People Give Up Pay to Get OptionsEconomists tell us there is
no free lunch, so if someone gets options they must be giving up pay or
benefits. To be sure, some employees have done just that. There are
lots of people who were lured to start-up companies at lower salaries
in return for substantial option packages. But these people are the
exceptions. For the most part, they are at the managerial level or
higher, or people with special skills, such as programmers. Altogether,
they comprise only a tiny portion of all the employees getting options.
Data from Professors Joseph Blasi and Douglas Kruse at Rutgers
University indicate that, overall, employees getting options are paid
about seven percent more in wages than comparable employees in
comparable companies that do not give out options. The fact is that
with a tight labor market -- and we still have a labor market that is
tighter than historical standards -- it is very difficult to lure all
but a handful of risk-takers to jobs whose base pay and benefits are
not comparable to what could be earned elsewhere. Options are gravy to
help companies distinguish themselves. In the tech sector, they are not
even that -- everyone gives out options widely, so they are just part
of the ante to the game.
#3: Most People Give Up Pay to Get OptionsEconomists tell us there is
no free lunch, so if someone gets options they must be giving up pay or
benefits. To be sure, some employees have done just that. There are
lots of people who were lured to start-up companies at lower salaries
in return for substantial option packages. But these people are the
exceptions. For the most part, they are at the managerial level or
higher, or people with special skills, such as programmers. Altogether,
they comprise only a tiny portion of all the employees getting options.
Data from Professors Joseph Blasi and Douglas Kruse at Rutgers
University indicate that, overall, employees getting options are paid
about seven percent more in wages than comparable employees in
comparable companies that do not give out options. The fact is that
with a tight labor market -- and we still have a labor market that is
tighter than historical standards -- it is very difficult to lure all
but a handful of risk-takers to jobs whose base pay and benefits are
not comparable to what could be earned elsewhere. Options are gravy to
help companies distinguish themselves. In the tech sector, they are not
even that -- everyone gives out options widely, so they are just part
of the ante to the game.
Myth #4: Options Are
Worthwhile Only If Your Company Is Publicly TradedMany stories advised
employees that if their company was not on a public stock market, their
options were worthless and would be until the company did an IPO --
which very few ever would do. In fact, most closely held companies
giving out options are sold (assuming they don't close first), at which
time the options are usually exchanged for cash or for stock in the
acquiring company at the sale price.
Worthwhile Only If Your Company Is Publicly TradedMany stories advised
employees that if their company was not on a public stock market, their
options were worthless and would be until the company did an IPO --
which very few ever would do. In fact, most closely held companies
giving out options are sold (assuming they don't close first), at which
time the options are usually exchanged for cash or for stock in the
acquiring company at the sale price.
Myth #5: Options Are the Last
Decade's CompensationSurely, this myth goes, no one wants options any
more. Lots of employees have lots of options deeply "underwater,"
meaning the price at which the employee can buy shares is way above the
current price, making the option probably worthless. So who wants more?
Moreover, many companies, worried about new accounting rules, will, it
is argued, cut back on their plans. Employees do, and employers want
them to have them. Data from the National Center for Employee Ownership
show that most companies with broad-based stock options plans have no
plans to change, much less eliminate them. Surveys show most companies
with broad-based equity plans will keep them, although some may change
their terms (such as by giving employees fewer years after vesting to
exercise) or even switch to some other form of equity compensation, as
did Microsoft. The rise in the stock market that followed the steep
drop starting in March 2000 has largely overcome the feeling that
equity compensation may be less relevant. Concerns about accounting and
tougher shareholder approval rules are more serious issues. We expect
that companies who made largely symbolic broad-based grants will drop
their programs, but companies who incorporated equity into their
corporate cultures will not. Meanwhile, the widely expected shortage of
skilled workers that is expected to materialize this decade will
pressure more companies to grant equity broadly, just as it did in the
1990s
Decade's CompensationSurely, this myth goes, no one wants options any
more. Lots of employees have lots of options deeply "underwater,"
meaning the price at which the employee can buy shares is way above the
current price, making the option probably worthless. So who wants more?
Moreover, many companies, worried about new accounting rules, will, it
is argued, cut back on their plans. Employees do, and employers want
them to have them. Data from the National Center for Employee Ownership
show that most companies with broad-based stock options plans have no
plans to change, much less eliminate them. Surveys show most companies
with broad-based equity plans will keep them, although some may change
their terms (such as by giving employees fewer years after vesting to
exercise) or even switch to some other form of equity compensation, as
did Microsoft. The rise in the stock market that followed the steep
drop starting in March 2000 has largely overcome the feeling that
equity compensation may be less relevant. Concerns about accounting and
tougher shareholder approval rules are more serious issues. We expect
that companies who made largely symbolic broad-based grants will drop
their programs, but companies who incorporated equity into their
corporate cultures will not. Meanwhile, the widely expected shortage of
skilled workers that is expected to materialize this decade will
pressure more companies to grant equity broadly, just as it did in the
1990s