Last July, when Microsoft Corp. (MSFT ) announced that it would no longer grant stock options, pundits declared the end of a golden era for the tech industry. Now, though, Microsoft archrival IBM (IBM ) has given a boost to the practice of handing out options to valuable employees -- which helped fuel the tech boom of the 1990s even as excessive grants to executives outraged shareholders.
On Feb. 24, Big Blue announced a new options program for its top 300 execs that's unprecedented in Corporate America. Starting this year, under a so-called premium price plan, the IBM stock price will have to increase by at least 10% from their grant prices before executives are allowed to exercise options, which vest over four years. If the stock appreciates by 20%, the executive will collect a 10% gain while shareholders pocket 20%. Starting next year, execs also will be able to tap into a second pool of options as part of a "buy-first" plan. To qualify, they must first buy shares on the open market using up to 10% of their annual bonuses and hold the stock for at least three years. To qualify for options with a target value of $18,000, for instance, they would have to buy $9,000 worth of stock. The new programs are expected to go into effect next year for all 5,000 executives.
Other companies, take note: This program bears serious consideration. It should do a good job of aligning the interests of execs and shareholders. Because of the 10% hurdle, executives get their reward only after shareholders get theirs -- and they don't gain as much as shareholders do. And because execs must spend their own money on stock on the open market to qualify for the "buy-first" program, they have skin in the game. If the stock price sinks, so does an exec's net worth. To top it off, the program reduces a hit to earnings if companies are required to expense options starting next year. "It's a good model. It's tough," says management consultant Don Tapscott. "But this is the new era when management is being held to higher expectations."
The IBM program got its start last summer about the time Microsoft made its options splash. CEO Samuel J. Palmisano asked execs to come up with a new compensation plan that responded to shareholder dissatisfaction with the big options paydays of the 1990s. J. Randall MacDonald, IBM's senior vice-president for human resources, says it wasn't a response to Microsoft's move to restricted stock, but it was designed partly to set an example for others. "This is a change-agent strategy," he says. "What worked no longer works, and we're out in front."
Should others follow suit? "For large tech companies, it's a pretty good model. But it's important for companies to customize to their circumstances," says Don Lowman, managing director at human resources specialist Towers Perrin. While the program is obviously tailored for an industry giant, it could work for smaller, fast-growing companies as well. IBM's stock rose 19% last year, but many smaller tech stocks soared by more than 50%, so their employees could have enjoyed big gains even with a restrictive plan like IBM's. Already, several German companies, including software giant SAP (SAP ), have adopted premium-priced options programs such as IBM's.
The program can also serve as a model for companies to reduce a hit to earnings once options are expensed. Under the IBM plan, the 10% gap between the market price at grant and the strike prices will reduce the earnings impact of options granted by about 8%, says Steven Hinden, director of executive compensation for IBM.
Make no mistake, this is a nervy move for IBM. Doubtless Big Blue will lose some talent to other companies that are willing to slather on the perks. But compensation and management experts believe the program is generous enough to help IBM recruit and retain top execs.
Indeed, IBM's move signals that it's time for tech companies to get smart about stock options, not give up on them. Even though the expected expensing rule means fewer will be granted, CEOs should be able to figure out how to make options a vital part of their compensation packages and corporate cultures. With policies like IBM's, tech execs will still get to savor their stock options. The difference is, now they'll be sitting at the table with shareholders rather than eating alone.
By Steve Hamm