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10/24/2003
11:27 AM
William Schaff
William Schaff
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Taking Stock: Readers Sound Off On Stock Options

Employees should get a percentage of net profits, a reader says

My recent article on repricing stock options struck a chord with readers ("Stay Wary About The Repricing Of Options," Oct. 13, p. 88). There were so many insightful comments that I thought it would be worthwhile to respond to a few.

Reader No. 1: "You say: 'Yet there's a big downside for the current shareholders, since it dilutes their share of earnings by increasing the number of shares outstanding.' This may or may not be true. Some companies can and do 'fund' option grants with repurchased shares. Also, one doesn't get to keep all the appreciation, if any, in an option exercise. Uncle Sam claims a goodly chunk. Tech-company utilization of options is for sure an extreme and distasteful issue, but let's not throw everyone in that boat."

Response: Absolutely. Abusive use of options isn't systemic. However, repurchased shares do represent profits that could have gone to common shareholders' equity instead of just eliminating the dilution aspect of exercised options. And, yes, taxes are clearly a consequence, but the largest federal tax hit is a 33% incremental ordinary tax rate. Assuming California's top incremental state tax rate of 9.3%, the combined maximum tax is roughly 40%, so option holders still end up with 60% of the residual value. The problem in the recent past has been exercising options, owing tax, but not selling the stock once exercised until the value went below the actual tax bill. Now, that hurts.

Reader No. 2: "I'm not sure your numbers represent the true picture. In your example, the company reprices and its fully diluted count goes up by 5%. In most repricing scenarios, the number of shares goes down (i.e., you get, say, one for two or one for three)."

Response: This is true; in many cases, the number of shares to be repriced goes down, reducing the overall impact on shareholders. I have less of a problem with the rank and file getting these benefits under this scenario than with the senior management team getting them. Most senior members are given additional options every year and others after a certain period. At that time, the new pool is priced to then-current market value. If senior managers believe the original options were fairly priced at the beginning, they have assumed a certain amount of business and financial risk. They're also in the best position to see the benefits.

Reader No. 3: "Earnings per share and dilution mean little to the person who may be counting on the options as additional income--almost as little as the influence most employees have in influencing stock price. Stock price is really influenced by the market. The way to reward employees that make a difference is through a percentage of net profits."

Response: Excellent solution, but not usually practical at bigger companies. Actually, this is an insightful comment as to how most employees view options.

I thank all my readers for their wisdom and insight. Stay diligent.

William Schaff is chief investment officer at Bay Isle Financial LLC, which manages the InformationWeek 100 Stock Index. Reach him at bschaff@bayisle.com. This article is provided for information purposes only and should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any security. Bay Isle has no affiliation with, nor does it receive compensation from, any of the companies mentioned above. Bay Isle's current client portfolios may own publicly traded securities in one or more of these companies at any given time.


To discuss this column with other readers, please visit William Schaff's forum on the Listening Post.

To find out more about William Schaff, please visit his page on the Listening Post.

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