Deloitte Survey Shows a Third of Companies Dropping Broad-Based Options

In its new 2005 Stock Compensation Survey, Deloitte Consulting LLP reports that 75% of responding companies plan to reduce, or had already reduced, the number of options they grant. Public companies were more likely to reduce options than private companies, by an 83% to 53% margin. The survey included 343 companies, 69% of which were public and 31% private. The biggest impact will be on lower-level employees, although it is worth noting that about two-thirds of the companies with broad-based equity award plans will keep them in some form, and around two-thirds of companies with ESPPs will either keep the plans as they are or make changes that keep the plans very attractive to employees. The survey was conducted in the second quarter of 2005. Just over half (52%) of the companies were in technology, media, and telecommunications. Company size varied from very small to very large.

The changes are much less a reaction to new rules on options expensing than to shareholder pressure. Eighty-three percent of the respondents say that they do not think expensing will affect stock prices, and only 20% of the private companies say that expensing will affect their plans to go public. Shareholder pressure to put a lid on dilution is a much more compelling factor. Seventy-three percent of public companies and 64% of private companies said they would try to keep dilution under 15% or less. Run rates (the percentage of shares made available for awards each year) are generally targeted at 2% or less.

Reductions in options are coming mostly at the non-executive level, with 46% of public and 45% of private companies following this path. One-third of the public and one-fourth of the private companies plan cuts across the board. Only 6% of respondents are dropping executive options, and only 11% are reducing the size of the grants to this group. By contrast, 36% of the companies say had reduced or eliminated option eligibility for exempt employees, and 33% are doing the same for non-exempt employees. The size of the grants at these levels was being reduced in 41% of the cases. In fact, 32% of the public and 23% of the private companies are eliminating grants for all non-exempt employees. The results did not differ significantly by broad industry grouping. Where equity awards were being eliminated for a group of employees, 42% of public and 31% of private companies will not replace them with any other kind of benefit.

ESPPs

Employee stock purchase plans have raised little shareholder ire, but a number of companies seem to be taking advantage of the new expensing rules to pare back or eliminate these plans. While ESPPs are very popular at some companies, at others they attract relatively low participation and investment, partly because some companies make little effort to promote or explain them. Of the 60% of public companies in the survey with ESPPs, 28% anticipate making changes, 43% will make no changes, and 29% have not decided. Reducing the discount or look-back period (the time period during which an employee can "look back" to a previous date's stock price to make a purchase) are the most popular alternatives, with about half the companies making changes favoring these approaches. About 30% of the companies making changes, however, will simply offer a 5% discount on the shares, with no look-back (the accounting "safe harbor" that incurs no expense), while 8% will eliminate the plan. Most experts agree that offering such a small discount effectively kills the program.

Global ESPPs are even more vulnerable. Of the 53 companies with these plans, a quarter will eliminate them and another 24% will conform to the safe harbor. Still, 42% plan to at least keep the 15% discount.

Alternative Plans

Among the 79% of companies considering changes, 45% said they would be increasing their use of time-vested restricted stock or restricted stock units, 36% performance-vested restricted stock or restricted stock units, 25% performance-vested options, 24% performance-granted restricted stock or units, and 18% stock appreciation rights, with smaller support for other strategies.

Valuation Models

Despite all the discussion of alternative valuation models, 41% of the companies plan to use the Black-Scholes model, compared to 11% choosing a lattice model. Other companies have not decided.

Significance

The data are very much in line with other surveys. Overall, they reach several key conclusions:

• Although much of the impetus for option reform was to reduce the amount of equity grants to top executives, there is no reason to think this will happen.
• Outright awards to a broad base of employees will be reduced, but a significant majority of companies with these plans will keep many of their essential features, albeit some of these will reduce the size of the awards.
• ESPPs will be significantly reduced or eliminated in perhaps a quarter to third of the companies, but the remaining companies will continue a commitment to the basic outline of these plans.

In short, the damage to broad-based equity plans, while notable in comparison to awards at the top, is significant, but not as dramatic as some people had feared.