BUSINESSWEEK ONLINE : DECEMBER 11, 2000 ISSUE
BUSINESS WEEK E.BIZ -- NET WORTH When Good Options Go Bad Issuing special stock options to keep staff may not be the best answer Joseph H. Howell, chief financial officer of EMusic.com Inc. (EMUS), agonized as he watched the stock price of his Internet music retailer tumble this year. Although he fretted about the California company's diminished worth on Wall Street, he was even more bothered by the prospect of massive defections among his 180 employees. Most of the workers held stock options priced at about $16 a share, and, by spring, EMusic's stock was trading at about $2. So in June, he decided to grant his workers a new batch of options priced at $2. ''We're trying to make sure that our employees are receiving a good compensation package in an extremely competitive market,'' says Howell. His anxiety is shared by plenty of other executives. Throughout the 1990s, stock options were perceived as an enlightened way to compensate employees and to bring their interests in line with those of shareholders. The National Center for Employee Ownership estimates that more than 10 million people are receiving stock options today, up from 1 million in 1992. While all of this worked wonderfully during the eight-year bull market, the crash in stock prices during the past six months is exposing the dark side of options. Employees at uber-portal Yahoo! Inc. (YHOO) saw the value of their options drop by 60% to $13.2 billion between June 30 and Nov. 16, according to UBS Warburg economist Jeffrey A. Palma. The value of options held by workers at Dell Computer Corp. (DELL) was cut in half to $8 billion over the same period. And the options of Intel Corp. (INTC) staffers tumbled 40% to $4.5 billion. The price of the losses is measured in more than dollars. A steep drop in the value of stock options can wreak havoc on morale and send workers fleeing for the exits. Suddenly, chief executives across the country, particularly at tech companies, are struggling to find effective ways to recruit, motivate, and retain employees. ''People were counting on what wasn't real,'' says Steve Ballmer, Microsoft Corp.'s CEO. ''I think that that is really a tough situation.'' He knows the difficulties of inflated expectations and deflated stock options only too well. In April, Microsoft (MSFT) gave all of its 35,000 employees a special, one-time options grant equal in size to the options they had received as part of their 1999 performance reviews. That followed a drop in the software giant's shares from nearly $120 in December to about $66 in April. Net retailer Amazon.com Inc. (AMZN) granted employees new stock options in August, after its stock had tumbled from $113 in December to $30.75. At Sprint Corp. (FON), after the stock fell 65%, to $24, during the past year, employees could decide whether to trade in their existing options for new ones that will be priced at the market value of Sprint's shares in May. ''Employees are at a premium in a difficult hiring market, and we have to be competitive,'' says E.J. Holland Jr., vice-president for compensation, benefits, and labor relations at Sprint. While hanging on to employees is exceptionally tough in the tech sector, companies across the board are hardly immune. More than a dozen companies have repriced options or given special option grants this year--with about one-quarter of those in companies outside the tech sector. They run the gamut, from retailer Toys 'R' Us (TOY) to management consultant Navigant Consulting (NCI) to Franklin Covey Inc. (FC), the professional-services firm whose vice-chairman, Stephen R. Covey, wrote The 7 Habits of Highly Effective People. Twisted logic. All these new option awards may sound nice for companies and their employees, but they're making institutional investors furious. Why? Existing shareholders are the big losers when workers get special option grants. Each new share granted to employees leaves the old stockholders with a smaller piece of the company. ''The choppiness in the marketplace, along with the tight labor market, is not a good enough reason to award additional options,'' says John F. Nelson, investment director of small company stocks at the State of Wisconsin Investment Board, a pension fund with $70 billion in assets. ''That's not the type of logic that we'd like to see for any type of compensation.'' Investors think the logic is twisted in another way, too. While options were supposed to align the interests of employees and shareholders, the recent special awards and repricings do the opposite. Workers are rewarded when the stock price drops, while investors suffer. ''It's a case of 'heads I win, tails I win,' and that's completely unacceptable,'' says Nell Minow, the Washington, D.C., editor of The eCorporateLibrary.com, an online corporate-governance think tank headquartered in Portland, Maine. ''Until the day shareholders' holdings are repriced along with the options, the employees shouldn't have theirs [repriced] either.'' Companies feel as if they have little choice. Tech players, in particular, attracted the best and the brightest--not just with the promise of changing the world but also with the allure of dizzying riches. Without potentially lucrative stock options, these companies may lose MBAs and other top-notch recruits to traditional sectors such as consulting and financial services. ''The notion that money grows on trees and stories of people getting rich overnight has lost most of its credibility,'' says Ilya Talman, president of Roy Talman & Associates, a Chicago recruiting firm. ''People are much more conservative now.'' The scenario is grim--but experts on corporate governance say this is only the beginning. They expect a wave of repricings and special options grants in the next few months as companies take steps to halt a potential exodus of employees. ''The longer the tech stocks and dot-com prices are [down], the more of this we're going to see,'' says James E. Heard, chairman and CEO at Proxy Monitor, a New York advisory for institutional investors. ''I expect to see a flood of it in the next few months.'' Some compensation experts take the side of companies that argue that they've redone option plans simply out of necessity. ''High-tech companies can either give the new, lower-priced options to their existing employees or to the newer recruits who replace them,'' says Robert J. Salwen, a principal at Executive Compensation Corp., a New York-based compensation consulting firm. In such a scenario, both the company and shareholders would benefit from awarding the same options to existing employees. Of course, options aren't the only way to compensate employees. Many companies are boosting salaries and handing out extra-fat bonuses to keep workers happy. One example is the The Knot Inc. (KNOT), a New York firm that runs a wedding-planning site called TheKnot.com. When the company started in 1996, it paid employees much less than they could earn elsewhere. But now it has been forced to boost salaries in the aftermath of its stock plunging 90%, from $21 to $2. ''My COO and CFO took 50% to 80% pay cuts when they came on board, but now we've adjusted to the marketplace,'' says David Liu, the company's CEO. Besides granting new options, EMusic also has bumped up salaries and is handing out bonuses so that employees receive total compensation that the company figures is above market rates. Many tech workers may end up wishing they had received cash instead of a new round of options. Consider Garden.com Inc. (GDEN), an online seller of plants, flowers, and garden supplies. Back in May, CEO Clifford A. Sharples handed out 1 million new options to his 200 employees because most of their existing options had become worthless--the company's stock had slid from $10 to less than $2. But Garden.com's decline didn't stop in May. As losses continued to pile up, shares dropped to 25 cents. Then on Nov. 15, Sharples announced that the company was closing its doors. A raft of new options may shore up morale for a while, but it's no guarantee of corporate success. By PALLAVI GOGOI Contributing: Louis Lavelle _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ BACK TO TOP					e.biz Contents for Dec. 11, 2000 issue RELATED ITEMS When Good Options Go Bad TABLE: Tech Companies Consider Their Options INTERACT E-Mail to Business Week Online

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