Equity Compensation Models Are Changing Rapidly at Leading U.S. Technology Companies, Towers Perrin Research Finds; Aggregate Grants Are Reduced 20% Amid FAS 123® Compliance and Institutional Shareholder Pressure

Business Wire, July 21, 2005

STAMFORD, Conn. -- A new study by Towers Perrin, a global professional services firm, finds institutional pressure and pending stock option expensing are changing the landscape of how technology firms use equity-based compensation to attract, retain and reward their employees. The Towers Perrin Equity Compensation Strategy Pulse Survey finds the technology sector is rapidly diversifying the type, size and structure of equity vehicles they grant to nearly all levels of employees.

The survey, which included 30 of the nation's largest technology companies, with average sales of $4.4 billion, found more than half (53%) of the companies have begun using a mix of alternate compensation vehicles this year, predominately by reducing stock option grants and increasing the use of restricted stock or stock units.

"We are seeing the beginning of a dynamic shift in the way technology companies are using equity compensation to attract and retain talent," said Lane Ringlee, principal and senior Executive Compensation consultant in the firm's HR Services business. "As little as two or three years ago, the technology sector's common practice was to grant all of its employees stock options, and most new hires received an initial award. Today, amid new regulations and increasing pressure from institutional shareholders, nearly half of the companies we surveyed use equity vehicles beyond stock options, and they are also changing the eligibility requirements," he added.

The Evolution of Equity Compensation

Technology companies traditionally relied heavily on the use of stock option grants in their compensation strategies, with the goal of attracting and retaining the best talent. As recently as three years ago, the industry norm allowed all employees to be eligible for option grants and almost all new employees received an initial option grant at hire. Additionally, at a fixed time each year, employees would be considered for supplemental "replenishment" option grants, usually based on their individual performance.

The implementation of FAS 123(R), which changes how companies account for employee equity-based compensation in their financial statements, combined with increasing pressure from institutional shareholders and their concerns about equity dilution and share availability, have brought tremendous pressure on corporate America to change equity compensation practices. The result has been that many technology companies, historically the greatest proponents of equity-based compensation, have begun reducing new-hire option grant levels, mainly for management (20% decrease) and staff (30% decrease). Executive and existing employee grant guidelines have largely remained in line with previous years.

"Shareholders expect members of management and other key contributors to accumulate and hold a meaningful equity stake in the firm. The change in accounting rules, and the concomitant change that we're observing in equity granting practices, doesn't alter that expectation," said Ringlee.

While many companies are seeking shareholder approval to permit grants of stock award vehicles other than option grants, surprisingly, the research found 40% of companies have decided not to change their employee stock purchase plans (ESPPs) regardless of the future expense they'll incur under FAS 123(R); however, more than one-third (36%) continue to be in the "wait and see" mode. To a lesser degree, companies are eliminating their ESPPs or avoiding the expense by going to a "Safe Harbor" position that avoids any charge to earnings (5% discount and no lookback feature). Companies that have modified ESPPs most often have done so by decreasing the lookback period (71%) and reducing the discount percentage (14%).

Options vs. Grants

The volatility inherent to U.S. technology equities has bolstered a perception that "whole share" stock grants, such as restricted stock or performance shares, have a lower risk than "incremental value" grants such as options. In fact, more than half (53%) of the companies surveyed are executing exchange rates of one share of restricted stock to nearly three stock options. Half of the participating organizations noted they will reduce the aggregate number of equity shares (in whatever combination of options and whole shares) granted this year; 27% said the aggregate number will remain the same; 10% will increase the aggregate number, and 13% haven't yet decided. Of companies that have made changes in stock option grant policies, 45% cited FAS 123(R) as the primary reason and another 34% cited pressure from shareholders.

Eligibility

There is no clear indication that companies are reducing eligibility to receive annual (as opposed to new hire) stock options. Where eligibility requirements are tightening, most of the change can be seen at the staff levels (generally 40% decrease). Stock option plans for executive-level employees remain intact, with 82% of companies surveyed reporting no changes in eligibility.

About the Survey

Towers Perrin's Equity Compensation Strategy Pulse Survey was designed to help identify changes in equity compensation strategies at technology companies in the United States. The survey examined the type of equity award, size of individual awards, size of the aggregate award, eligibility at various levels of the organization, anticipated stock plan changes and ESPP design features. The data were collected in April 2005 from 30 technology organizations with average revenues of $4.4 billion.