New Study Shows Continued Decline in Options Use

While "Realities of Executive Compensation, 2006/2007," a new study from Watson Wyatt, focuses on executive compensation issues, the report also contains important findings on the use of options generally in large public companies. The study looked at the 793 companies in the S&P "Super 1500" for which there were data from 2001 through 2005. The study shows that the average option grant value per company had declined from $100 million to $29 million. The impact on earnings also declined, from 19 cents per share to 11 cents per share. Part of this was due to lower grant sizes. The average run rate, for instance, declined from 2.7% in 2001 to 1.6% in 2005. But part of the change was due to different assumptions about option valuation, with expected option lives now estimated to be down from 5.6 years to 5.2 years and volatility down from 47% to 38% from pre-FAS 123(R) requirements. These differing assumptions lower the reported impact of options on earnings.

Dilution from options, however, only declined from 9.7% to 9.1% over the period, largely because more options were being exercised while fewer were being forfeited. The result is that the gain realized on options is only marginally different from 2001. At the same time, companies are granting more restricted shares, primarily to executives.

The authors note that companies are reducing run rates in part by cutting off eligibility to lower-paid employees, a practice they say is counterproductive given the demonstrated value of broad-based plans.