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May 20, 2005
Firms Revamp Executive Compensation Before Stock Option Deadline

Nearly three-fourths (71 percent) of large companies are revising or plan to revise their long-term incentive program design in anticipation of mandatory stock option expensing, according to a survey by Hewitt Associates, a human resources services firm.

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The survey of 115 large U.S. companies found that many organizations are shifting a portion of their long-term incentive mix from stock options to restricted stock (43 percent) and performance-based shares/units (33 percent).

What's more, 35 percent of companies said they are limiting the number of employees eligible for long-term incentive plans.

"As corporate boards come under increasing scrutiny from shareholders and regulators, they're shifting more executive pay to performance-based equity, which has a greater focus on long-term results," says Tracy Davis, senior consultant for Hewitt Associates. "Moving forward, we expect this to have a major impact on executive earning potential, as a growing portion of their pay will be determined by their success in achieving long-term business goals and how well they meet shareholder expectations."

The Financial Accounting Standards Board has issued a rule that requires public companies to recognize the compensation cost relating to stock options in financial statements. The Securities and Exchange Commission is requiring companies to implement the rule by the start of their next fiscal year that begins after June 15, 2005, or December 15, 2005 for small business issuers.

Hewitt's study also found that many companies (42 percent) aren't fully replacing stock option grant values as they move to other forms of equity incentives. Approximately 40 percent of companies are using a 3-to-1 value ratio when converting to restricted stock, and a 4-to-1 ratio when converting to performance-based shares, according to the survey. Only a minority of companies are fully replacing stock option values in shifting to other forms of incentive compensation.

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