An Overlooked Labor Cost
Up to now, the big story about stock options has been how they have created a lot of fat cats in upper-management ranks--helping to push annual pay of CEOs of large public companies up 442% in the 1990s, to an average $10.6 million last year (BW--Apr. 19). But while the soaring options of top brass have made headlines, economist Joseph Carson of Deutsche Bank thinks the real news about options may be the way they are affecting key economic statistics--and thus possibly distortinG the views of policymakers and investors.
"Options," says Carson, "represent a significantly greater potential income gain for workers, and cost to companies, than many people think."
As evidence, he cites a Deutsche Bank study of the companies in the Standard & Poor's 500-stock index. The study finds that 99% grant stock options to employees. It also calculates that, based on exercise prices, the aggregate potential cost to employees of all outstanding options of S&P 500 companies at the end of 1998 was $265.7 billion.
The critical number, however, is the market value of unexercised options as share prices rise. Deutsche Bank researchers estimate that this stood at $543.5 billion at the end of June. That translates into a net gain of $278 billion over the cost of exercising those options--an amount equal to 78% of total 1998 profits of all S&P 500 companies.
The catch for investors is that options aren't treated as expenses in income statements until they are exercised. And that has an impact on market perceptions in two ways.
First, it tends to inflate reported earnings. At a late-August central bank conference in Jackson Hole, Wyo., Federal Reserve ChairMan Alan Greenspan estimated that not recognizing the cost of options when they're granted (and when their exercise prices are lowered) has pushed up the annual growth rates of reported profits by one or two percentage points over the past five years.
Second, the growing value of outstanding stock options over their exercise prices represents a potential cost for companies. At some future point, observes Carson, "that expense will weigh on company earnings."
The flip side of this picture, of course, is that options are a form of compensation. And while they're hardly spread equally or widely, that's less true than in the past. Consultancy William M. Mercer Inc. reports that nearly 40% of large U.S. companies now have option plans for at least half their employees. Carson calculates that the market value of unexercised options as of June 30 equates to a $17,000 gain per S&P 500 worker.
The growing use of stock options, he notes, implies that pay gains may be understated. And it's likely that recipients regard their rising value as another form of savings and potential income--adding fuel to consumption and helping to drag down the official savings rate.
"Options are no longer simply perks for a few top executives," he says. "Their increasing size and breadth are making policymakers in Washington sit up and take notice."