Tech: When Options Costs More Than Research

If you want to spur innovation, is it better to lavish stock-based compensation on employees or boost spending on research and development? The question is posed implicitly by a recent study that compared R&D spending with stock options and restricted stock awarded to employees of tech companies. The surprising finding: Quite a few companies, including Apple (AAPL) and eBay (EBAY), gave out more in stock pay in 2008 than they spent on research.

The comparison is aimed at helping investors decide whether companies are striking the right balance between employee pay and other obligations and expenses, says the report's author, Jack T. Ciesielski, founder of Baltimore investment and research firm R.G. Associates. "It makes sense for investors to relate [stock compensation] to other uses for these same dollars," he says. Among the other things companies could have done with their stock or the proceeds of a public stock sale: pay down debt, increase capital expenditure, strengthen the pension fund, or just shore up the balance sheet.

For technology companies, R&D can serve as lifeblood—the route to higher-margin, breakout products. But U.S. companies spend less on it than they used to and now rank fifth among 40 nations in a report issued earlier this year by the Information Technology & Innovation Foundation (ITIF), a Washington-based think tank. Apple and eBay were among six companies in the Standard & Poor's 500-stock index that spent more on stock gifts last year than on research, Ciesielski found.

At a time of intense public debate over the size of CEO pay, the findings may rankle some who believe U.S. corporations are paying executives too much and innovating too little. At the same time, many in the technology industry consider compensation that is tied to the future performance of a stock an effective way to induce employees to hatch creative ideas and cutting-edge products. Using options can also free up R&D resources, says ITIF President Robert D. Atkinson. "With options you can make the argument that you're not paying cash and that would allow you to do more R&D than you otherwise would," he says.

Jabil, Akamai challenge comparisonsJabil Circuit (JBL), an electronics design firm based in St. Petersburg, Fla., made more than $100 million in stock grants last year but spent just $33 million on R&D, R.G. Associates says. Akamai Technology (AKAM), which runs a network of distributed servers across the globe, spent $64 million on R&D—including what was capitalized—and $88 million on stock grants. (CRM), Apple, eBay, and St. Peters (Mo.) based MEMC Electronic Materials (WFR), maker of silicon wafers, all granted more stock-based pay than they budgeted for research last year, Ciesielski says.

Some companies on the list question how the figures are put together, and say the stark comparison of stock-based pay to R&D paints a misleading picture of their corporate priorities. Akamai CFO J.D. Sherman says the broad numbers mask important factors specific to his company. For instance, Akamai has been carefully managing its stock grants and tying many of them to tough performance metrics, so numerous grants will never be issued, Sherman notes. The point was echoed by Jabil spokeswoman Beth Waters—who added that, as a services company, Jabil would logically spend less on research than the manufacturers on the list.

"This makes us look like we're being irresponsible, underspending on R&D and overspending on compensation," Akamai's Sherman says. The fairer metric would be to look at stock compensation as a percentage of a company's earnings or revenue or to look at the stock option overhang's impact on market capitalization, Sherman says. It's not fair, he adds, to "compare it to any single line. For us that's not a valid comparison." Apple declined to comment. Representatives of eBay and didn't respond to requests for comment.

MEMC: broadly dispersed stock payCiesielski defends his firm's approach. "Which do they place more importance on?" he asks. "It's valid to compare what they're spending in stock grants to what they're spending on research and development…. The comparison is what you think the employees are worth and what you think R&D is worth." He concedes that it's important to consider the fact that some grants are performance-based, but says comparing grants to earnings or revenue or even market capitalization also has flaws, since "the actions of management do not necessarily make the stock go up in any one year."

Another question to consider is what segment of the workforce is getting the options, says Atkinson. Companies often give out little information about how much goes to managers vs. the rank and file, but certainly in many technology companies, stock pay is fairly broadly spread. That is the case at MEMC, says spokesman Bill Michalek, who notes that "everyone participates down to the machinists in Malaysia." Maybe more important, Michalek says, is the fact that on more common metrics, MEMC's stock compensation is low compared with many. Stock expense last year was just 8¢ a share, or 2% of earnings—low for technology companies. MEMC also happens to have especially efficient R&D, Michalek argues, because it has decades of experience and home-grown processes, including highly accurate modeling programs that allow researchers to simulate processes rather than having to undertake expensive experiments.

Apple CEO Steve Jobs famously said: "Innovation distinguishes between a leader and a follower." Although the company's $1.4 billion in 2008 stock grants is quite high, so too is its $1.1 billion R&D budget. Jobs himself received no stock compensation at all last year for a total compensation of $1. And few would credibly complain that the maker of the iPhone, the iPod, and the Macintosh computer is a laggard in innovation.

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