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Employee Stock-Options Have Lost Their Appeal

By Gene Colter

The biggest of the big aren't waiting for a final ruling on how to account for employee stock options: They are turning to other types of compensation.

Many of these companies, looking for ways to reward service or pay executives their just perks, are favoring restricted stock, according to a study to be released today. Restricted stock comes in a number of forms and with different names, but all versions require continued service by the employee. Stocks or cash tied to business performance are gaining prominence.

A U.S. accounting standard that requires companies to book stock options as an expense is expected to be made final before the end of the year by the Financial Accounting Standards Board. Congress is also in on the act, however (to the general dismay of accounting wonks), and a bill covering the treatment of options is hung up in the Senate. In recent years, especially during the halcyon days of the technology boom, stock options were handed out liberally with no direct impact on companies' bottom lines, because most of these options, which critics contend impose a real economic cost on companies, weren't booked as expenses. They simply were referenced in footnotes in annual reports.

Nevertheless, nearly 70 of the top 250 companies in the Standard & Poor's 500-stock index have become "early adopters" of Financial Accounting Standard 123, which requires booking options as an expense, according to the study by Frederic W. Cook & Co., a research firm that tracks trends in executive compensation. Among these companies, chief executive officers are starting to get more of their total pay from perks other than options.

For companies adopting FAS 123, the percentage of CEOs' total, long-term incentive pay consisting of stock options fell to 58% in 2003 from 73% of the total value in 2001, according to the study, which was based on the 2004 proxies from the top 250 companies in the S&P 500.

Even companies that don't expense are delivering fewer options: They accounted for 71% of total long-term incentive pay in 2003 at these companies, down from 81% a couple of years earlier.

Over half, 54%, of the top S&P 250 companies are using restricted stock, up from 43% in 2001. The use of so-called performance shares and long-term cash awards is also on the upswing.

The study shows that long-term incentive values declined from 2001 to 2003 but are creeping up again, even as the use of options falls. The recent refattening of pay packages presumably reflects the overall improvement in corporate earnings in the past couple of years.

Regardless, companies' executive pay packages are "going to be a lower risk profile portfolio going forward," Edward Graskamp, managing director at Frederic W. Cooke, said in an interview.

Companies will continue to gravitate toward performance goals when awarding nonsalary compensation, Mr. Graskamp said. As such, the jobs of corporate compensation committees will be getting even tougher. In years past, it didn't take much brain power to dole out options, because the options didn't have an immediate impact on financial performance.

"It's a very tough thing to do in a challenging economic environment to set multiyear performance goals," Mr. Graskamp said. "Compensation committees aren't just going to make these easy performance targets."

A person familiar with the FASB's efforts on expensing stock options said a side benefit of that project has been to get compensation committees to look more broadly at different types of pay, and many are choosing performance-based equity compensation.

Sure enough, the use of performance shares and performance units is on the upswing among the biggest companies, according to the study. As their name implies, these instruments typically require the employee or his or her unit to meet a specific performance goal related to fundamental performance. Stock options, in contrast, come with a strike price at which the holder can exercise the option, and executives for years have been criticized for chasing a higher stock price as the ultimate goal, even if the underlying business was floundering.

So far, Microsoft Corp. is probably the most high-profile issuer of performance-based grants. It gave some employees stock tied to customer satisfaction.