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Five Common Myths About Broad-Based Equity Plans

By Corey Rosen, NCEO Executive Director

February 2005

During 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-Coms

One 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 Companies

The 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 Options

Economists 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 Traded

Many 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 Compensation

Surely, 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.

This article is available for reprinting, with approved attribution. Contact the author at CRosen@nceo.org. An electronic (Word) version can be sent on request.

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