No Options The big guys may be letting stock options go, but should you?
Opinions expressed by Entrepreneur contributors are their own.
Stock options helped create the tech boom of the '90s, butsome large corporations like Microsoft are starting to dropthem.
While this strategy makes sense for large corporations whereoptions can distort accounting and corrupt executivedecision-making, entrepreneurs may be better off sticking to thestatus quo.
"If stock options make people work hard, make gooddecisions and generate cash flow, why would an entrepreneur walkaway from them?" asks David F. Larcker, professor ofaccounting at the Wharton School in Philadelphia. Options attracttop talent and spur productivity. But small businesses need toconfront the prospect of new regulations that will force companiesto count options as a business expense and weigh options'ability to boost earnings against balance sheet costs. "Ifoptions made sense before expensing, they'll make sense afterexpensing," Larcker says.
To many economists, options still come out ahead forentrepreneurs when compared to the alternatives. Fortune 500companies planning to abandon options, for example, are choosingrestricted stock instead. But this method is a poor choice forsmall businesses, say many observers, because it rewards longevitymore than performance. Indexed and premium-priced options, twovariations on the standard stock option, represent better, ifsomewhat flawed, choices.
Indexed options return financial gain when the company stockrises above a chosen index. In one example, an option held when thestock climbed 10 percent and the Russell 1000 grew 20 percent wouldhave no value since the company had underperformed. If the indexhad fallen 20 percent but the stock climbed 40 percent, the optionwould be worth the difference. Premium-priced options come with anexercise price set higher than the market price to spur managementto work toward pushing share prices higher. The more the sharesexceed the premium price, the more valuable the option.
Both methods seek to link options more closely to performance,but entrepreneurs should approach each with caution. "The morethese options affect the ability for an executive to make aprofit," says Dan Ryterbrand, managing director of Frederic W.Cook & Co. Inc., a New York City-based compensation consultingfirm, "the less the perceived value."
