July 26 2002

Commentary

Endangering the ability to own a piece of America

By Robert H. Linnell

Senator Phil Gramm (R TX), opposed an amendment to Senate legislation that would limit the use of stock options, stating “More than six million nonexecutive workers in America receive stock options every year”. He went on to say “we want to be sure that we are not endangering their ability to own a piece of America”. These statements are not true. Perhaps Gramm has been influenced by the fact that he received handsome campaign finance donations from Enron and his wife was a Director, profiting considerably from that connection. Ken Lay and other top dogs at Enron earned hundreds of millions from their options.

Stock options give the holder the right to buy, at a future date, company stock at a fixed price, usually the price at the time the option is issued.

The option has value only if the stock price goes up, usually caused by increased company sales and profits. The incentive is to increase company sales and profits; it did not seem to occur to anyone that these increases could come from “cooking the books”, making it appear that sales and profits were increasing although the truth might be the opposite. This is exactly what happened at Enron, Global Crossing, WorldCom and others that we may not know about. This uncertainty is a major factor hanging over Wall Street today. “What company will be next” is the question not “Will there be another company”.

No one contests the fact that stock options are a form of compensation. Favorable rules exempt options as a cost and permit tax deductions; employees receiving the options have no tax consequence until the options are exercised. Many corporate leaders favor stock options, especially in high tech industries. Support comes in part because generous option grants are used to lure personnel at below market salaries. Profits have been immense. Gary Winnick, former head of Global Crossing and two of his Directors pocketed $1.1 billion from sale of their option granted stock; Army Secretory White, formerly of Enron Energy, came away with over $10 million. What is the impact of options on most company employees and on stockholders?

It is estimated that fair option pricing would lower average company profits by 10%. For some it would be much larger. The argument that it is not possible to price options is clearly not true. Coke has announced that it will treat options as a cost and that it will ask two investment banks to price their value. Markets for options have existed for years and it is easy to price them. S and P, the well-known financial information company, has announced that it will start deducting the expense of stock options from company core earnings and is asking companies to report option grants quarterly rather that annually. Option expenses have grown rapidly in recent years; at Microsoft options cost $3.3 billion in 2001, some 30% of net income but they were able to get some $2.1 billion in tax benefits. It is clear that stock options have a negative impact on stockholders, diluting earnings and limiting stock prices.

Back to Senator Gramm and his incorrect statements (lies?). The total number of employees receiving options last year was 3 million or less, depending on whose study results you accept. The Senator has exaggerated the number of employees receiving options by at least a factor of two. Secondly 75% of options outstanding in 2000 were held by only the top 5 executives and 15% more were held by the next 50 top executives leaving a total of 10% for all the rest of those millions of employees! Those nonexecutive employees that Senator Gramm is concerned about have only 10% of all options granted and in a 1999 analysis, only 2.2% of employees earning less than $50,000 (the vast majority of all employees) received any options. Many workers, as at Enron, bought company stock through 401k or other pension plans and lost all or most of their investment while the bosses made their millions. It is this corrupt option system that is “endangering” the ability of workers to own a piece of America. It urgently needs to be fixed. Workers don’t benefit now.

Those business interests made wealthy by options have very powerful lobbies in Washington. Although Congress is poised to pass significant new legislation to deal with corporate malfeasance, dealing with stock options is not in the legislation. The stock market slide has continued because investors no longer trust Wall Street. To create trust, options must be dealt with. Options must be treated as a company cost and should not have any special tax treatment. Floyd Norris, in the New York Times, made the excellent suggestion that when options are exercised the stock must be held at least 6 months before it could be sold. Prior to 1991, stock obtained from options had to be held 6 months before it could be sold, otherwise the profits had to be given to the company.This rule prevented executives from cashing out options, selling the stock at once (as they have recently been doing) only to have the company announce bad news soon thereafter, causing the stock price to plummet and creating the (probably correct) impression that the executives selling their stock knew the bad news was coming.

We must let Congress know that options must be dealt with to restore faith in Wall Street and rescue the investments of all of us who depend on the capitalistic system for our future.

Reproduced with permission from: www.my-oped.com.

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