Pocket Pickers

By Daniel Kadlec

The battle raging over stock-option accounting is enough to put most folks to sleep. Yet 14 million workers in broad-based stock-option plans have a direct financial stake in this skirmish--as do, it turns out, many folks who invest in common stocks. Recent studies have concluded that companies with widely dispersed options outperform companies that grant options only at the executive level. This adds a layer of drama to the latest efforts to require that options grants be treated as an expense that reduces reported profits. No one expects fat-cat execs to take a big hit on their own overall pay. To offset the costs, they would cut rank-and-file options plans--and in the process squash a valuable investor ally.

The airline industry shows how broad-based options plans relate to performance. Shares of Southwest Airlines, which has long included many employees in its plan, have risen threefold in the past 10 years. Delta, which shelved its broad plan in 1998 and grants options only to executives, has fallen 80%. JetBlue, which has a broad-based plan, has been a winning investment since its debut two years ago. American Airlines had been dead money for 10 years; then it started to distribute options broadly, and in the past 14 months the stock has tripled.

The airlines are going through wrenching change, and many forces are moving these stocks. But it's no coincidence that the companies spreading options around to most employees are rising to the top. It's much the same across industries. Companies like Starbucks, Pfizer, Whole Foods and Washington Mutual have broad plans. Each is a leader in its field and boasts an outperforming stock. "Do companies with broad-based options plans get more out of their employees? Or is it simply that companies that are good in the first place grant most employees options?" asks Corey Rosen, executive director of the National Center for Employee Ownership. "We don't know, but it doesn't matter." The result, he says, is that broad options plans correlate with high returns.

This isn't foolproof. In the tech industry, where the vast majority of companies grant options to the rank and file, not all can end up winners. Indeed, many have taken their lumps of late. Still, a study by Douglas Kruse, Joseph Blasi and Jim Sesil of Rutgers University and Maya Krumova of the New York Institute of Technology found that productivity rises almost 15% and return on assets rises 2.5% after a company adopts a broad-based options plan. Other studies have found that merely announcing a broad plan boosts a stock nearly 2% and that the benefits are consistent in large and small companies in both bull and bear markets.

Options are in the spotlight because earlier this year the Financial Accounting Standards Board voted to require companies to treat them as an expense, making clear a cost that had been relegated to the footnotes. The tech world, which claims it needs stock options to attract good employees, has led the opposition. No lesser lights than Warren Buffett and Alan Greenspan have endorsed expensing. Here's the rub: surveys show that if options must be expensed, nearly half the companies with broad plans will cut back grants to the rank and file, while only a handful will cut equity-based compensation to executives. "We'd have to rethink our ability to provide stock options to all employees," says Marc Jones, CEO of Visionael, where the expensing rule would chop $1.5 million off reported profits.

Seeking to preserve options grants for the masses, a House committee in late June approved a bill that would require companies to expense only the options they grant to the top five executives. The bill makes little accounting sense and defeats the purpose of reform. It will never stand, just as the boss will never cut his plan and leave yours intact. --With reporting by Eric Roston/Washington

With reporting by Eric Roston/Washington