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October 17, 2000

Corporate America Faces Declining Value of Options
By Robert McGough, excerpted from The Wall Street Journal

Tech Wreck Will Drive Up Wages ... Weiss comments

NEW YORK - Corporate America's experiment with the mass issuance of employee stock options is entering a new, and more worrisome, stage.

These options helped power the technology boom in recent years, because they allowed technology companies to pay employees in a way that wasn't recorded as an expense. Tax deductions from the exercise of these options drastically cut taxes for booming tech concerns. And the income that consumers realized, and spent, when they cashed in their options helped fuel the economy to greater heights.

Now that stock prices are sharply lower, however, those golden stock options are worth less -- or worth nothing, in many cases. Despite Friday's strong rebound, stock prices remain way off their highs. And options, instead of being a benefit to companies and the economy, could start being -- yikes! -- a burden.

How much of a decline has there been in the value of employee stock options? As calculated by Joseph Carson, an economist at UBS Warburg, the market value of employee stock options on June 30 for companies in the Standard & Poor's 500 stock index, was $893 billion. By Thursday, that value had dropped about $125 billion, or 14%, to $768 billion. Calculated another way, deducting the strike price needed to exercise the options, the decline in value is even steeper: a 22% drop to $445 billion from $570 billion.

At some big options-happy companies, the drop in value has been especially precipitous, according to Mr. Carson's calculations. At Dell Computer, the value of employee stock options, adjusted for the cost of exercising them, has fallen by more than half, to $7.5 billion on Thursday from $15.8 billion on June 30. The value of stock options outstanding at Intel has dropped 44%, or $18.1 billion, to $22.7 billion. Microsoft has shed about $20 billion in options' value. At Lucent and WorldCom, the companies' stock prices actually fell below the weighted-average exercise price of their options, making the market value of their employee stock options, as calculated by UBS Warburg, equal to zero.

Companies that issued large numbers of stock options may start to owe considerably more in taxes. And they may need to pay valuable employees more cash as compensation, or see the employees leave for others that will.

One fix for underwater options that companies used to take -- repricing the existing options to reflect the company's lower stock price -- isn't attractive anymore. Accounting rules now require companies that reprice employee stock options to take a charge to earnings if those repriced options become valuable again. Moreover, institutional investors take umbrage at repriced options, which they say reward poor performance. And nowadays, no company wants to give investors any additional reason to sell their shares.

When a market starts reversing course, sometimes the factors that propelled it higher begin to work against it. Employee stock options, it would appear, could follow that pattern, as the virtuous circle turns vicious.

For a while, tech companies were getting the best of both worlds -- highly skilled employees at low salaries and a tax break on top! Now, these companies will be paying their fair share of taxes. Corporate profit margins certainly won't be as fat as they once were, meaning tech companies will be in for another round of punishment from Wall Street.

Plus, now that the options of battered techs aren't worth the paper they're printed on, employees will demand cold hard cash when negotiating salaries. With the labor market as tight as it is, they'll certainly have leverage.

So, the beaten-down tech industry will drive the market lower even as wages shoot through the roof. The tech sector was praised as the source of the increase in productivity that helped stave off inflation. Now, it will get the blame when wage inflation adds to the economy's woes.

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