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January 01, 2000
Are Stock Options Getting out of Control?
Man
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y experts are concerned that the current mania over employee stock options is way out of control; both working against its intended purposes and possibly endangering the economy.

A Great Idea

Stock options are a terrific idea on paper. They tie the employee's compensation to the long-term future of the company, aligning both their interests. They are a virtual necessity for start-up companies seeking to recruit hard to find workers. And no top officer in any public company would dream of taking a new job without the prospect of millions of dollars of stock option profits in his future. Even Labor Secretary Alexis Herman, licking DOL's wounds after a bruising battle over its stock options and overtime opinion letter, has lately come on singing the praises of stock options in our booming economy.

So why the fuss?

So why the fuss in the media like the (Internet trade magazine) Industry Standard and the New York Times? Because according to many, the idea has gotten to be a case of too much of a good thing. Whereas Internet start-ups used to feature stock options with one year cliffs and four-five year vesting, increasingly the trend is for companies desperate for talent to shorten these minimal controls. In some cases outright gifts of stock are being made, taking away much of the risk . Other companies, obviously intent on short term horizons, are even providing options that vest immediately at 50 or 100% if the outfit goes public, or is acquired.

Where did the incentive go?

A one year cliff means that the employee can't use any of the options for one year, and then he or she can only sell that stock or options that have been vested. Take away the cliff, and shorten the vesting period, and critics charge you have also taken away most of the risk and the long-term incentive. In short, many believe companies are giving away plenty while getting little in return. Other compensation expert, however, say that given the job-hopping orientation of many new media employees, vesting schedules are now meaningless as a retention tool.

Too much overhang

An increasing number of actual shares of stock are being given to executives outright. But another, deeper, concern centers over how many stock options are out there as the popularity of stock options has grown. If and when they are cashed in, companies will have to come up with vast sums of money to buy their stock and give it to executives. Critics, even Alan Greenspan, worry about the effect this often overlooked expense will have on corporation's fiscal health, as well as the resulting diluting effect it will have on other shareholders.

Changing the strike price

Compensation people and watch dog groups also center on the problem that hasn't happened too much lately - what happens when the stock price goes down, or never appreciates enough to get the stock option out from "under water". For example, if an employee is issued options to buy the stock at $20 and the price of the stock never goes above $15 during the time it could be exercised, the employee gets nothing. Solution: many companies re-price old options, say at $10, so a profit can be made. Critics pounce on this practice (and the federal government imposes tax implications in certain circumstances), saying that the idea was to get the executive to tie her fortune to the company's stock price - this practice removes the risk and the incentive.

The future

Stock options appear to be such a popular tool there are here to stay for a while. Look for shorter cliffs and vesting schedules, deeper penetration into the company , and potential increased government regulation in the short term. In the long term, the economy will take over. If stock prices tank, or when we enter a recession, count on some corrections to current excesses.

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