Which Is Better -- Stock or Options?

When the e-mail went out that there was to be a companywide meeting on July 8 at 2 p.m., few Microsoft Corp. employees knew what was in store. Top management had carefully guarded the fact that Microsoft would halt its stock-option grants to employees in favor of restricted stock. Even managers weren't informed until half an hour before Chief Executive Steve Ballmer's speech.

If Ballmer was afraid that employees would revolt at the demise of one of the building blocks of Microsoft's culture and dominance, the brass needn't have worried. The Redmond (Wash.) software maker's rank and file had been watching their options sink deeper under water for the past three years. "Everyone I've talked to has said this is a better thing," says one Microsoft manager who asked not to be named. "I do not believe Microsoft or companies in our genre will see the same kind of growth [we had] before and I don't think anyone at a gut level believes the stock price will go up like that again."

While options once made Microsoft a storied place that minted millionaires, today many of Microsoft's 1.6 billion options are worthless. Without a fast-appreciating stock, options cease to be much of a tool for retention or motivation. It's a problem that a lot of companies are grappling with.

That means that plenty of folks are likely to face the same question Microsoft employees are mulling: Over the long term, which is a better deal, stock or stock options? That depends on the performance of their company's stock. If it lags or only grows at a modest rate, they're better off with the stock. Usually workers get a certain number of restricted shares provided they meet some hurdle -- often something as simple as staying with the company for the next three years. At that point, they're free to cash in their shares. So unless the stock has fallen to zero, the employee is ahead.

Options on the other hand are far riskier. They represent the right to buy the stock at a point in the future at a preset price, usually the price when the options are granted. If the stock climbs above that strike price, the worker is in the money. If it falls, he or she is in the same boat as the holders of all those worthless Microsoft options -- nowhere.

Because options are riskier, they're usually valued lower than shares and given in greater numbers. According to compensation consultant Steven E. Hall, president of Pearl Meyer & Partners, an employee generally gets three to four stock options for every share of restricted stock.

Which is worth more over the long haul depends on how quickly the stock appreciates. Ira T. Kay, director of the compensation practice at consultant Watson Wyatt Worldwide, says that the equalization point is usually around 10% to 15% annual appreciation. If your stock goes up more than that, you'd be better off with options. Otherwise, you'd be better off with restricted stock.

There are other factors to consider as well. At companies that pay big dividends, employees might do better with restricted shares because an amount equivalent to the dividend starts to accumulate from the day the shares are granted. With options, dividends kick in only if the option is exercised and the shares are held.

Restricted shares, however, are trickier when it comes to taxes. You can pay an income tax on them up front and then owe only capital-gains tax on the appreciation from that date forward. But you would forfeit that tax payment if the shares failed to vest -- for example, if you left the company. Alternatively, you could pay Uncle Sam when the shares vest, but you'd lose the lower capital-gains rate on the appreciation.

Even in a tough market, many technology workers still want options. John Jennings, director of systems integration for Sun Microsystems Inc., says that stock options helped him finance a home in Silicon Valley, vacations, and his kids' college funds. "I work in high tech because it's a high-risk, high-reward business," says Jennings, who has been at Sun for 10 years. "If Sun didn't have stock options, I might be looking elsewhere." Time will tell if it's Sun's employees or Microsoft's who are on the right side of that bet.

By Nanette Byrnes in New York

    Before it's here, it's on the Bloomberg Terminal.
    LEARN MORE