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JULY 10, 2003
This May Be the End of the Options Era Microsoft's move to ditch stock options in favor of restricted-stock grants, combined with a FASB ruling, could push the rest of techdom to abandon them, too A year ago, Microsoft Chief Executive Steven A. Ballmer was asked why the company didn't take a leadership role in reforming tech-industry accounting. Why, an analyst asked, didn't the tech giant deduct the cost of stock options from its earnings? Ballmer's response: Others in the tech world say the fallout would be "very, very gloomy." As a leader, Microsoft stood by its industry. No more. On July 8, Microsoft (MSFT ) did the unthinkable: It scrapped stock options, eliminating a form of pay that made thousands of Microsoft employees millionaires and helped define the culture of the tech industry. Instead, starting in September, the company will pay its 54,000 employees with restricted stock, a move that will let employees make money even if the company's share price declines. Like stock options, the restricted stock will vest gradually over a five-year period from the issue date. Under accounting rules, grants of restricted stock are counted as expenses and charged against earnings. "A SMARTER WAY"? Microsoft's explanation for the switch was the "angst" it faced from employees whose stock options were worthless. "We asked: Is there a smarter way to compensate our people, a way that would make them feel even more excited about their financial deal at Microsoft and at the same time be something that was at least as good for the shareholders as today's compensation package?" says Ballmer. More than just altering one company's pay program, the move promises to change forever a perk that is as closely linked with technology as the assembly line is with the auto business. "This marks the beginning of the end of the options compensation era," says Robert B. Austrian, an analyst with Banc of America Securities. Stock options paved techdom with gold, making millionaires out of top execs and rank-and-file software programmers alike. But critics argue that they distorted company earnings, camouflaging an expense that never showed up on the bottom line. In response, the Financial Accounting Standards Board is preparing a rule that would require expensing of stock options. Here's how Microsoft's move will affect employees, investors, and the tech industry. What does this move say about Microsoft? No company has been more of an icon of the tech boom over the past quarter-century than this software giant. But as the company nears its third decade, its financial performance has become staid. Sales, which climbed an average 36% a year through the 1990s, haven't cracked 16% growth this decade. In the 1990s, Microsoft shares grew nearly 100-fold, from a split-adjusted 60 cents to $59.19. Share prices have been halved since the 1999 peak. The new pay plan is a tacit admission that Microsoft isn't the growth stock it used to be. Microsoft shares haven't kept pace with others in the industry. Its stock is up 6.3% this year, compared with a 43.6% rise in the Merrill Lynch 100 Tech index. What does the change mean for Microsoft employees? The biggest shift is that employees can get some value from their stock even if the price doesn't climb. That may not seem like much of a motivational force. But with shares well off their 1999 high, virtually all the options granted since then are worthless. That means the 20,000 employees who joined Microsoft in the past three years have seen little or no benefit from their stock compensation. Now, employees will still have a strong incentive to improve the performance of the company and its stock price. But they don't have to wait for the gargantuan price jumps of the past decade -- jumps that aren't likely to come from a mature company, anyway. Their existing stock options won't be worthless, either. Under the new plan, which needs regulatory approval, employees can elect to sell their options to J.P. Morgan. In an e-mail to employees, Ballmer wrote that at a Microsoft stock price of $25, the company expects that options with a grant price ranging from $33 to $34 could be sold for approximately $1.80 to $2.10 each. Not much, but it's better than nothing.
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