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The Employee Ownership Update

Corey Rosen

August 16, 2002

(Corey Rosen)

Efforts to Revive Pension Reform to Continue After Recess

Senate Democrats have pledged to try to revive pension reform legislation after the August recess. Negotiators have been trying to iron out differences between the bills passed by the Senate Finance Committee, which is similar to, but somewhat stricter, than the House-passed bill, and the Senate Labor Committee, which is much tougher. If a bill did pass the Senate, it would still have to go to a conference committee. Given the dwindling number of legislative days and other unresolved issues, prospects for pension reform this year look uncertain at best.

IQuantic/Buck Survey Shows Companies Would Cut Back Broad Options if Expensing Required

A new survey by iQuantic/Buck Consultants has found that if the responding companies were required to expense options, over half would make non-exempt employees ineligible for options. The survey was performed in the summer of 2002 and asked companies how they would react if the International Accounting Standards Board's (IASB) proposed rules for stock plan expensing were adopted. The IASB wants to require companies to expense all stock awards, including stock purchase plans and options, at the time of grant based on a present value calculation. 117 companies responded to the survey, 61% of which were in high-technology, 21% in life sciences, and 18% in general industry.

Of the surveyed companies, two-thirds of the life sciences respondents, 52% of the high-technology companies, and 50% of the general industry companies made grants to non-exempt employees, while about three quarters of the technology and life sciences companies, and 43% of the general industry companies, made them available to individual exempt employees. 83% of the high-tech companies have employee stock purchase plans (ESPPs), compared to 58% of the life sciences companies and 52% of the general industry companies.

While most companies reported that they had not yet had formal discussions about how they would react if the IASB proposals were implemented, most respondents believed that expensing stock grants would lead to a change in compensation philosophy, especially in the high tech-sector (72% of these companies said it would, compared to just over 40% for the other companies). 60% of the high-tech companies would make non-exempt employees ineligible for options, compared to 55% of life sciences companies, and 44% of general industry companies. Just over half of both high-tech and general industry companies would make individual exempt contributors (engineers, programmers, sales staff, etc.) ineligible in both general industry and high-tech, while 39% of general industry companies would. Senior executives would not be excluded, and few companies would exclude other top managers. About 80% of all respondents would reduce the total number of options granted. About one-third of all respondents would drop the ESPP programs. About half the companies would consider performance-based options, but less than 25% would consider indexed options (options that only have value of a company does better than its peers or the market).

The results need to be viewed with some caution. Companies might be more restrained in the restriction of option eligibility if, as many people expect, options expensing proves to be less significant to share prices than is often feared. Moreover, in the current somewhat overheated environment, it is easy to say that employees will become ineligible for a benefit, either options or an ESPP, but actually doing the deed will be much harder, causing potentially significant damage to employee morale in some companies. Finally, retaining options for executives while cutting them for rank-and-file employees will create a public relations nightmare while doing little to improve reported earnings. Option grants and ESPPs for non-executives account for less than half of all option awards even in companies granting them broadly; grants to non-exempt employees account for less than 20%.

Copies of the study are available by calling Michael Bendorf at iQuantic/Buck at 415-437-6216.

United's Bankruptcy Flirtation and Employee Ownership

The announcement by Untied Airlines that is might file for bankruptcy has prompted a number of media stories on whether the employee ownership plan at the company was part of the problem (see, for instance, the excellent article on this topic in the New York Times August 15). The media has been fairly neutral on the issue so far, but some observers have more pronounced views. Gordon Bethune, CEO of Continental Airliens, told the Times that employee ownership at United was like "inmates running the asylum and having access to the pharmacy," a sentiment shared by many stock analysts. In fact, employees do not run United, but rather have three seats (a minority) on its board and veto power over some strategic decisions. The only point at which their power may have prevented United's board from acting how it would have anyway was in delaying the USAir merger, but even there, the Machinists voted yes, and the merger ultimately failed because of economic and legal questions. There is also no reason to believe that board presence affected labor negotiations. United's employees got substantial raises, but their packages followed common industry patterns.

The real failure of employee ownership at United was that neither union nor management leadership chose to use it to create an "ownership culture," such as that in evidence at Southwest, where employees have a large ownership stake through a profit sharing plan invested in Southwest stock and broad-based options. At Southwest, employees work in teams to make decisions, get lots of information about the company, and have considerable individual authority to do what is needed. At United, this was tried successfully for one year, then abandoned as management and labor went back to their old adversarial style. Moreover, United's ESOP has a very unusual five-year life; most ESOPs are intended to be permanent. So both sides knew that "this too shall pass." Flight attendants were also kept out of the plan (by mutual agreement), meaning there were no "employee owners" meeting people on the planes. Finally, employees took concessions to get the ESOP (something that is very rare), leaving many with a bitter association with the plan form the start.

Overall, ESOPs clearly do improve corporate performance; at United, at best, ownership did not help and may have hurt.

American Electronics Association Study Shows 84% of Tech Workers Get Options

A new study of employees working for publicly traded high-technology companies shows that 84% of employees receive stock options. Officers of the company get 34% of the value of the options granted. The study was performed by the American Electronics Association, and asked just two questions: "Over the past three years, what percentage of your employees were granted stock options," and "What is the percentage of all stock options granted that go to officers of the corporation?"

The study was sent to 525 companies, one-third of whom responded. 60% of the companies grant options to all employees. As with any survey of this kind, caution must be used in interpreting the results. Our experience tells us that different companies will interpret the phrase "your employees" differently, with some just measuring full-time employees meeting basic service requirements, and others taking it more literally. Still, the results confirm the widely held view that technology companies generally make options universal or close to it.

Financial Services Firms to Expense Options

Members of the Financial Services Forum, a group of large financial services companies, have announced they will all expense options. Members include Allstate, American Express, American International Group, Bank One, Bank of America, Bank of New York, Citigroup, FleetBoston Financial, Goldman Sachs, Household International, J.P. Morgan Chase, Merrill Lynch, MetLife, Morgan Stanley, Prudential, State Street, and Wachovia.

FASB Allows Alternatives for Companies Expensing Options; Moves of Requiring Quarterly Footnote Disclosure for Those Not Expensing

The Financial Standards Accounting Board (FASB) has announced it will allow companies who voluntarily choose to expense options to use any of three approaches to starting the practice:
  1. To recognize costs only for awards granted after the beginning of the fiscal year in which the change is announced.
  2. To recognize costs for new awards plus and unvested outstanding awards.
  3. To recognize costs for the year of the change and all prior years had Statement 123 been in effect as of its effective date (going back to 1995, in other words).

Companies might choose the first method because it minimizes the current cost. However, this approach would mean that in the second and subsequent years, the costs would cascade. That's because the portion of vested options in the first year will be relatively small; in the second year there will be new grants plus old grants that vest. This would increase for another two or three years in most companies before reaching equilibrium. So some companies will prefer to take the entire hit now for unvested options. Companies might choose the third method if their costs are small and they want to make a public relations statement.

At the same time, FASB announced that it will issue an exposure draft requiring companies that do not expense options to record the cost using FAS 123 in their footnotes on a quarterly basis, not annually, as currently allowed.

FASB Turns Down AICPA Proposal on Pre-IPO Valuations

An effort by the American Institute of Certified Public Accountants (AICPA) to develop guidelines for valuing stock in pre-IPO companies was turned down by FASB, which must set GAAP standards. FASB members were concerned that the AICPA would not set standards that would prevent abuses. The AICPA approached the issue because of concerns about the issuance of "cheap stock" in pre-public offering companies. There are currently no guidelines about how such stock should be appraised. The AICPA may now develop a "white paper" instead.

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