Stock Option Expensing - 2003
August 2003

This report summarizes the findings of the 2003 WorldatWork survey on stock option expensing practices and opinions. For the second year in a row, WorldatWork surveyed a sample of members -- mostly compensation professionals in Fortune 1000 organizations -- in July to gain perspectives on common practices and changes regarding stock options and the issue of expensing.

In July 2002, a week after Coca-Cola announced that it would begin expensing employee stock options, WorldatWork surveyed a random sample of members to gauge their reactions to the Coca-Cola news and other related issues. The association planned to administer the same survey in July 2003, and the unexpected announcement by Microsoft -- almost a year to the day after Coca-Cola -- provided new public and media interest in the subject, and a new context for survey participants.

Methodology

In July 2003, surveys were sent electronically to a random representative sample of 6,229 WorldatWork members. A total of 413 responses were received, a 7-percent response rate. Because the demographic profile of the 413 survey respondents is similar to the WorldatWork membership as a whole, the responses can be considered statistically representative of the membership.

The WorldatWork membership generally consists of professionals at the manager level and higher, working in the headquarters of a large company in North America. The association�s membership tends to be from larger companies: 95 percent of the Fortune 1000 companies have at least one employee who is a WorldatWork member.

Summary of Key Findings

• The majority of compensation professionals do not believe stock options should be expensed, most frequently because of problems with valuation.
• Most professionals report their company is currently using non-expense accounting and taking a �wait and see� approach on option expensing.
• If either legislation or accounting standards in the near future were to require the expensing of employee stock options, professionals in companies currently offering options believe a shift would occur to restricted stock, smaller option grants, and/or a discontinuation of options to groups below the highest employee levels in their organizations.
• The Microsoft announcement that the company would shift from options to restricted shares has had little, if any effect, on companies� philosophies regarding stock options.
• Although the majority of compensation professionals do not believe stock option expensing will become a common practice by the end of 2003, they do think it will be by the end of 2004.

Detailed Findings

Of course, on a survey topic like employee stock options, it is best to have a significant proportion of publicly traded companies participate. Indeed, a majority of the professionals who participated in the survey (73%) indicated they were responding from a publicly traded organization. Professionals representing privately held organizations accounted for 19% of respondents; government, academic or not-for-profit organizations made up 8%.

Figure 1:�Please indicate whether your organization is:�

Nearly eight in ten respondents (79%) representing either publicly traded and privately held organizations indicated their organization currently has an employee stock option program. Only 2% of these respondents� organizations have discontinued their employee stock program in the past 12 months, and 20% never had a stock option program in place. Looking at publicly traded companies separately from private firms, the majority of publicly traded organizations (92%) have employee stock option programs, while the majority of privately held organizations (74%) do not. (See Figure 2.)

Figure 2: �Does your organization currently have an employee stock option program?�

Of those who reported that their organization currently has an employee stock option program, nearly half (46%) indicated that at least some employees are currently eligible to receive stock option grants. (See Figure 3.)

One-third (34%) of respondents reported that all employees in their organization are eligible for their �broad-based� stock option grant program. About one in ten (11%) reported that only officers and executives were eligible for stock options, and 9% of respondents reported �other� groups are currently eligible for the programs. Common responses provided in the open-ended �other� category probably could have been captured in the �some but not all� response: �key employees,� �professional employees,� and �exempt� or �salaried.�

Figure 3: �Which of the following groups of employees in your organization are currently eligible to receive stock option grants?�

For those respondents who reported an option program in which only �officers and executives� were eligible to receive stock option grants, about three out of five (59%) indicated that 100% of those who were eligible during the previous 12 months actually received an option grant. On average, 80% of officers and executives who were eligible received a stock option grant in the last 12 months. (See Figure 4.)

For those who reported an option program for �some, but not all employees,� just over three-quarters said that 100% of officers and executives received a stock option grant during the last 12 months (with an average of 83% actually receiving grants), and nearly a quarter indicated that 100% of management received a stock option grant in the last 12 months (with an average of 63% receiving grants).

For those with a broad-based stock option program, four out of five (82%) reported 100% of officers and executives received a stock option grant in the last 12 months (with an average of 90% receiving grants). Nearly two in five (38%) reported 100% of management received a stock option grant in the last 12 months (with an average of 75% receiving grants); and one-third (33%) reported 100% of all employees received a stock option grant in the last 12 months (and an average of 62% receiving grants).

Figure 4: Employee Groups Awarded Stock Option Grants in Past 12 Months

Shareholder Initiatives in 2003

A small percentage of survey participants (11%) reported that their company received a shareholder proposal to expense stock options in 2003. Of those who did report a proposal, 42% indicated that shareholders had approved the proposal. Media reports indicate that a new era of so-called �shareholder activism� may have been initiated in part due to the corporate accounting scandals of the past 18 months, and thus, proposals such as these may continue in the future. (See Figures 5 and 6.)

Figure 5. �In 2003, did your company have a shareholder proposal to expense stock options?�

Figure 6. �If yes, did it pass?�

Expensing Stock Options

By roughly a 3:2 margin, members of WorldatWork do not believe employee stock options should be expensed. A sixty-one percent majority of respondents indicated �no� to the question: �should stock options grants to employees be accounted for as an expense on the company�s income statement?� Less than one-third indicated ��yes� to the question (29%), reflecting an opinion that stock option grants to employees should be accounted for as an expense.

A third possible response, selected by the final 11 percent of respondents, allowed participants to provide an open-ended response with the lead in �Only if��. Answers varied widely, but the most common sentiment involved the notion of finding the right valuation model. A typical response was �Only if�a fair and accurate valuation method can be developed.�

Figure 7. "Should stock option grants to employees be accounted for as an expense on a company's income statement?"

Current Status Regarding FAS 123

The majority of companies in the survey are taking a wait-and-see approach regarding option expensing. A two-thirds majority of respondents (representing both publicly traded and privately held organizations that offer employee stock option programs) indicated their organization is currently using non-expense accounting, and that they are waiting to see if a change in accounting is forced by either legislation or accounting standards. A combined 26% indicated that their organization is either currently using FAS 123 or preparing to adopt it, both with and without Black Scholes. Finally, 7% chose to provide an open-ended �other� response, many of which related to �studying� the issue and/or transitioning to a new model. (See Figure 8.)

Figure 8. �Which of the following best describes where your company currently stands regarding stock option expensing?�

Impact of FAS 148

Nearly half of respondents (45%) with employee stock option programs indicated their organization is not electing FAS 123 in time to take advantage of the Dec. 15 FAS 148 deadline, while 17% are adopting FAS 123 for FAS 148. A large number of respondents (37%) indicated that this topic was not applicable to their organization.

Figure 9. �Is your organization adopting FAS 123 in time to take advantage of FAS 148?�

Impact of Possible Legislation/Regulatory Mandating Option Expensing

When survey participants were asked what effect possible legislation or regulatory action would have on their company�s practice of granting stock options, they were given the option to select from a variety of possible responses and indicate all possible choices.

In response to a similar question asked in the 2002 survey, nearly three-quarters of respondents answered that it was �too soon to tell.� This year, however, the �too soon to tell� response has dropped significantly, to 32%.

Slightly more than a third of respondents in 2003 (36%) indicated that their company would probably shift to restricted stock if legislation or regulatory action were to require expense accounting of employee stock options. Offering smaller stock grants was another action reported by one-third of respondents (31%). Less often noted were actions such as shifting to more cash incentives (13%) and making grants less frequently (12%).

Figure 10. �If legislation or regulatory action in the near future requires companies to fully expense employee stock options, what effect will this have on your company's practice of granting of stock options? (Check all that apply)�

Impact of Microsoft Announcement

Microsoft�s mid-July 2003 announcement that it would begin awarding employees with restricted stock shares instead of stock options had no effect on the stock option philosophy of many companies. In all, 63% percent said the announcement had no impact at their company. To the contrary, however, nearly 40% then said that the announcement had some effect, ranging from 25% saying it had a �minor effect� to a small minority of respondents (2%) who reported that Microsoft�s change would have a significant effect on their companies� stock option programs.

Figure 11. �Microsoft recently announced that it would begin to award employees with restricted shares instead of stock options. What effect, if any, has this announcement had on your company�s philosophy regarding stock options?�

When Will Stock Option Expensing Become Widespread?

Although more than 8 of ten respondents believe that expense accounting for stock options will not become a common practice by U.S. companies by the end of 2003, an equally high proportion believe that it will become by the end of 2004. (See Figures 12 and 13.)

Figure 12. �Whether it occurs through voluntary corporate movement or a mandated change in accounting rules, legislation, regulation, do you believe expense accounting for stock options will become a common practice by U.S. companies by the end of 2003?�

Figure 13.� �by the end of 2004?�

Survey Respondent Organization Demographics

Industry

Organization Size

About WorldatWork
WorldatWork is the world's leading not-for-profit professional association dedicated to knowledge leadership in compensation, benefits and total rewards. Founded in 1955, WorldatWork focuses on disciplines associated with attracting, retaining and motivating employees. In addition to providing professional affiliation, WorldatWork offers highly acclaimed certification (CCP^®, CBP^TM and GRP^®) and education programs, the monthly workspan^® magazine, online information resources, surveys, publications, conferences, research and networking opportunities. WorldatWork, 14040 N. Northsight Blvd., Scottsdale, AZ 85260, 877/951-9191, customerrelations@worldatwork.org