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JULY 10, 2003
This May Be the End of the Options Era [Page 2 of 2] What's the effect on earnings and accounting? Microsoft will announce on July 17 the impact on its earnings. With its report for its first fiscal-year quarter ending in September, the company will begin to account for the expense of new stock awards and for stock options that are vesting. The hit from the fresh expense could be as much as 23% of earnings, according to analysts at Goldman, Sachs & Co., who looked at the cost of past Microsoft stock-option payments. But the company probably won't have to hand out as many dollars' worth of stock as it did of stock options in order to satisfy employees. If it can cut its costs for stock-based compensation by one-fourth, its newly reported expenses would be about 17% of earnings. Microsoft is choosing to account conservatively for the ongoing vesting of options it has granted in the past. That means the potential advantage of switching to stock awards will phase in gradually. What's in it for Microsoft shareholders? Investors aren't too rattled. The day after the announcement, Microsoft shares fell 23 cents, or 0.8%, to $27.47 in a trading session in which the Dow Jones industrial average dropped 0.7%. Over the longer term, its stock price could go up, notes analyst David Bianco of brokerage UBS. Investors could be encouraged if Microsoft gets more output from employees because its stock compensation provides stronger incentives without extra cost. Plus, since Microsoft plans to hand out fewer restricted shares than it did stock options, it may not need to buy back as many shares, which could conserve cash and minimize dilution. What does Microsoft's move mean for other tech titans? Intel (INTC ), Cisco Systems (CSCO ), and others have vowed to keep issuing options. They argue that there is no accurate way to account for options and it would be a disaster, they say, if tech companies had to expense them. Unlike Microsoft, most tech outfits face fierce competitors in the U.S. and overseas. They believe stock options are a good way to keep competition from poaching key employees. These are legitimate concerns, but Microsoft's move and the expected ruling from FASB mean it's probably only a matter of time before the day of reckoning comes for the rest of the industry. There's already momentum in that direction in all types of corporations. According to Mercer Human Resources Consulting, a compensation consultancy, 220 companies have announced plans to expense options this year. And on July 9, DaimlerChrysler (DCX ) revealed that it is considering scrapping stock options. Won't expensing of options crimp innovative startups? Indeed it may. The FASB ruling will apply to private companies as well as public ones. Startups typically offer recruits generous grants of stock options because they can't afford the salaries that more established companies offer. They also say they need a come-on to convince talented people to give up secure positions and risk their careers on unproven companies. If these businesses have to expense stock options, it may take longer for them to achieve profitability, delaying an initial public offering and requiring them to raise additional venture-capital funds. With mandatory expensing, "it will be very hard to have a successful startup company in Silicon Valley or in the U.S.," warns Marc Benioff, CEO of Salesforce.com, a software company that is expected to go public next year. He may be overstating the case, but in a world that is increasingly hostile to startups, any additional burden makes it even more difficult for these innovators to thrive. What does this mean for executive compensation? With Microsoft as their trailblazer, expect many other companies to reexamine their compensation programs. Under the Microsoft plan, its top 600 executives and managers will receive most of their compensation in the form of restricted stock. The amounts will depend on growth in the company's customer base and improved customer satisfaction. Many other businesses will likely be persuaded by the Microsoft example to replace some option grants with restricted stock. But no one expects options to disappear entirely, whatever the cost. Compensation consultants say that options -- with their promise of a big payoff -- will remain an important, albeit smaller, part of the executive compensation landscape.
 By Jay Greene in Seattle, with Cliff Edwards in San Mateo, Calif., and Steve Hamm, David Henry, and Louis Lavelle in New York Get BusinessWeek directly on your desktop with our RSS feeds.  Add BusinessWeek news to your Web site with our headline feed. Click to buy an e-print or reprint of a BusinessWeek or BusinessWeek Online story or video. To subscribe online to BusinessWeek magazine, please click here. Learn more, go to the BusinessWeekOnline home page  | | |
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