Prof. Paul:
I have been brain dead for a while. The moment I regained consciousness and logged on to SI, I learned about your suspension. It was "news" -- of a sort, and want to tell you how sorry I am.
You have a lot of good friends here who can't afford to lose you. From the thousands of posts you have made, you not only cared to respond providing detailed explanations but also showed courtesy and consideration to others.
Efficiency accompanied by civility is a rare combination in today's virtual world. Keep posting and please hold on to your scholarly and gentlemanly ways.
Best regards,
Bennie
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Stock options is again the headline of the Money & Business section of The NY Times. Those who have followed you will find the article like a summary of your posts on different occasions.
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Silicon Valley Aftershocks: Are Stock Options Making U.S. Companies Shortsighted?
By REED ABELSON
When Dan Scheinman joined Cisco Systems in 1992, he was a neophyte in the ways of Silicon Valley. Leaving a job as an associate at a law firm, he was offered his choice at Cisco of a signing bonus or stock options in the company.
Scheinman chose the sure thing -- the bonus. And as Cisco's stock price, yoked to the growth of the Internet, soared over the years, this "goof," as he calls it, cost him roughly $700,000.
So Scheinman, now the company's general counsel, has become a true believer in the power of the stock options to create wealth. "The bigger risk is not getting options," he said. "Here, nobody thinks about salary any more."
Little wonder, given the huge windfalls that many technology stocks are providing employees -- and especially to certain top technology executives. Though their salaries tend to be modest by corporate standards, options are moving the leaders of companies like Cisco and Yahoo rapidly up the ranks of the country's most highly compensated chief executives, according to an analysis of executive pay conducted for The New York Times' Money & Business section.
Big grants of options -- which give the holder the right to buy shares at a set price for a specified time -- have long allowed technology companies to lure and retain employees without diverting cash from their own growth or damaging their often tenuous profitability. And by doing so, they have done what shareholders have demanded for a generation: linked management's interests to investors'.
But Silicon Valley's obsession with options -- an obsession increasingly shared by the rest of Corporate America -- is approaching an unhealthy extreme, according to some pay consultants, recruiters and even investors. Like Internet bubble babies, too many executives, these critics say, are focused on stock performance and stock performance alone.
"The thing that concerns me the most is the trend toward building market capitalization rather than building companies," said Roger McNamee, the founder of Integral Capital Partners, a Menlo Park, Calif., investment company that has backed such fast-growing companies as Rambus Inc. and Inktomi Corp.
The combination of option-rich pay packages and an overheated market -- one where the performance of certain Internet highfliers seems to have little to do with fundamental performance -- is creating an employment environment that resembles a lottery, according to pay experts.
Critics warn that these packages, many of which let executives quickly convert their options into stock, are not creating a loyal work force focused on the long term. Instead, they may be encouraging a short-term mindset by employees hoping to strike it rich by joining companies whose stocks seem ready to soar.
Companies have responded by offering even more options to keep key workers, ratcheting the stakes higher and higher. "It's upped the ante for both executive talent and key engineering talent," said Steve Patchel, a senior consultant for Watson Wyatt Worldwide, a pay and benefits consulting firm.
That route is being taken by many technology companies, according to Graef Crystal, the editor of the crystalreport.com, an Internet newsletter on executive pay, who conducted the study of last year's executive compensation for The Times' Money & Business section. When he looked at amounts being ladled out at a sampling of technology companies with ties to the Internet, he found that the average executive made more than twice as much as his counterpart in the rest of Corporate America -- entirely because many packages were stuffed with options.
But Crystal's calculations take into account only the size of the options grants themselves, not the rise in the companies' stocks. "Obviously, if you combine huge grant size with huge price performance, you get the fourth movement of Beethoven's Ninth, complete with a 350-voice chorus," Crystal said.
For example, the increase in the value of options in just the last year put Timothy Koogle, chief executive of Yahoo, in nearly the same pay league as John Welch of General Electric, even though GE's $100 billion in sales is 500 times more than Yahoo's $200 million. Koogle, with total compensation of $22.7 million, ranks among the 20 highest-paid executives in Crystal's study -- and that does not count the one-year jump of nearly a half-billion dollars in the value of his options. Not bad for someone who was brought in to run the company less than four years ago.
As Koogle's case shows, it is no longer just the Bill Gateses of the world who become enormously wealthy as technology booms. Executives who played no role in starting a company are being given stakes that provide them with wealth akin to that of founders who had to stake everything on their dreams.
"We are rewarding professional executives with entrepreneurial rewards," said Pearl Meyer, the president of Pearl Meyer & Partners, a New York consulting firm.
Yahoo says Koogle was brought in very early to the company and is largely responsible for its success. "He put the first business model in place," said Diane Hunt, a company spokeswoman.
The danger for businesses driven by high-spiraling stocks comes in a market reversal -- a development that, for all technology's power, many observers consider inevitable.
The technology sector, of course, has always had its ups and downs. But now many more people -- not just founders and top executives, but workers on the corporate front lines -- hold options and shares. That ties them for better and worse to the current cycle. And many have never experienced the worse.
Beyond that, many of the fresher faces in Silicon Valley "have begun to believe that they are worth the number" they are now earning, said Barry Obrand, who heads Silicon Area activities for Russell Reynolds Associates, an executive search firm. If stocks drop, he worries that many employees and executives will vanish as quickly as the paper profits on their holdings. Companies could have a hard time rebounding if key people depart.
Closer to home, the issue is what will happen to employees who have changed their life styles based on visions of a future bonanza. Anyone buying an expensive house or car, and expecting to cash in options to make the payments, could be in for a rude awakening.
To be sure, stock options are viewed as an important way to motivate employees and management. "You work differently; you work smarter," said Matt Ward, chief executive of WestWard Pay Strategies, a consulting concern in San Francisco. "Everybody's there to get the mission accomplished" -- that is, to bolster shareholder returns.
This mind-set is increasingly prevalent as companies across the country embrace a similar philosophy. "Options have become a bigger and bigger part of the pay package," said Crystal, who said options accounted for about half the total compensation paid to executives in his survey of 428 large companies.
But as large investors have begun to complain about how the corporate printing presses "keep running," as Crystal puts it, there are signs that the huge increases in pay may be moderating. While Crystal found that the median increase in compensation was nearly 25 percent in 1997 for chief executives of the biggest companies, it climbed only 10 percent last year.
The faithful in Silicon Valley are quick to assure cynics, especially those from the other coast, that the "money culture" is not pervasive. "We are building something that we want to be around in 10 years," said Scheinman of Cisco, which makes Internet networking equipment.
As long as the executives running these companies are representative of what some describe as Old Silicon Valley -- sharing an overarching belief in the ability of technology to change the world -- executives will still work 100 hours a week to try to get their latest products out on time, say defenders of the industry's ways. And programmers will still devote hours to perfecting a piece of code.
"The reason you don't have to worry about this is that the day-to-day environment is not about the stock price," said David Peterschmidt, chief executive of Inktomi, an Internet software company that has been among the hot upstarts of late. Since going public in June, the stock has more than quadrupled.
What's more, veterans say, it is well understood in Silicon Valley that many of even the most promising companies fail. "A lot of people have a lot of worthless options as wallpaper in their garage," said Ward of WestWard Pay. At Cisco, employees joke about former colleagues who sought their fortunes at some of these failures, Scheinman said, noting that "plenty of e-commerce companies have folded their tent."
But, oh the rewards -- if mostly only on paper -- for workers whose companies are embraced by investors. Given the recent success of Internet-related initial public offerings, companies that are planning to go public can use options to give employees potential for vast riches. "Most of these Internet companies can get anyone they want by dangling stock options," said Rick Gostyla, the head of the North American high-technology practice of Spencer Stuart, an executive search firm.
A decade ago, an executive recruited by a start-up might get $20 million in options, according to David Kixmiller, a partner at Heidrick & Struggles, another search firm. Today, the package is likely to be worth $100 million. "All the valuations are pushed up higher in every stage of the deal," Kixmiller said.
Moreover, many pay packages no longer lock employees into long-term relationships in order to collect the jackpots. Many companies are granting options that can be converted into stock relatively quickly, said Judith Fischer, the managing director of Executive Compensation Advisory Services in Springfield, Va.
Steven Westly, a vice president at Ebay, the online auction company whose stock has shot up 778 percent since its public offering in September, was given options on roughly 2.4 million shares at just 7 cents each when he joined the company in August 1997, according to company filings. Westly, who was free to exercise the options immediately, has done so, according to the filings. If he still holds the shares, he has a paper profit of more than $330 million. Ebay had no comment.
Even when companies offer more traditional options, which vest over several years, many allow a substantial fraction to be exercised in short order. At Silicon Graphics and Inktomi, for example, additional shares vest monthly.
That is why few consultants still argue that options are a tool to retain executives in Silicon Valleys. Companies lose as much as a fifth of their work force each year, according to the Radford division of Aon Consulting, which conducts an annual survey of high-technology companies. If a competitor wants to hire someone badly enough, it will simply offer enough new options to make up for any money left behind, pay experts say.
"Using a long-term incentive for short-term gains creates a problem," said David Leach, a consultant with Compensation Resource Group in New York. "It certainly sends a message of short term."
The siren call of options also penalizes companies whose stock has already been very successful, like America Online or the two-year-old Amazon.com or even corporate toddlers like Ebay. While companies point to past stock performance in recruiting prospects, a stock that has been TOO hot can make recruiting difficult. In such cases, executives and other candidates turn pessimistic, because "their stock has only one way to go," explained Gostyla of Spencer Stuart.
And woe to any company whose stock starts to struggle.
Silicon Graphics, which makes computer systems, has experienced an exodus since its stock started performing poorly a few years ago. To attract its new chief executive, Richard Belluzzo, from Hewlett-Packard, the company offered him a yearly salary of just under $1 million and 3 million stock options -- a fifth of which vest after just 10 months on the job. So he could exercise his Hewlett-Packard options, Silicon Graphics also gave Belluzo a short-term loan, which he has repaid, according to the proxy statement.
"To attract the best talent, you have to be competitive with the market," said John Cristofano, a spokesman for Silicon Graphics.
Like other technology companies with tumbling shares, Silicon Graphics has reduced its options' prices twice in the last two years. While many investors frown upon the practice, compensation experts say such companies have little choice if they hope to keep or attract key people.
Companies "feel that they cannot wait a year" for the stock to recover, Ms. Meyer said. "If they wait more than a quarter, they will have an outflow" of essential workers.
But the act of repricing options is being threatened by a change in the rules governing how companies account for options. The Financial Accounting Standards Board, the nation's accounting rule maker, has proposed that repricing options result in a charge to earnings if the stock price moves up. Many experts say this would all but end the practice, because companies would be very reluctant to incur the charges.
Within technology companies, few people seem to resent the enormous wealth being created in the Valley -- because that wealth is being at least partly shared.
That may be because many companies make a point of including all their employees in option plans. A survey of Internet service companies by WestWard Pay showed that half of workers making less than $30,000 were eligible for options.
While the proliferation of options is helping to keep the peace, it also means that a much larger group of people will suffer in any downturn.
When Hewlett-Packard lost significant market value more than a decade ago, employees did not head for the hills. "They didn't have stock options," said Kixmiller, the executive recruiter from Heidrick & Struggles. "Stock options were not as big a part of the landscape."
So what will happen when today's landscape is bombarded by what could be dozens of crashing stocks?
"We don't know the answer," said Kixmiller. "The valuation placed on the Internet IPOs is unprecedented."
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