Profit sharing theory is also relevant to stock based

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Unformatted text preview: to companies that pay higher compensation as a result of broad-based stock options ( Profit sharing theories would also tend to predict a positive connection between broad-based stock options and corporate performance (Kruse, 1993). Profit sharing theory is also relevant to stock-based compensation plans because of the empirical evidence indicating that lower level employees do essentially use such plans like cash profit sharing plans. Profit sharing theory thus suggests a more positive prediction. A number of microeconomic studies have found that profit sharing companies are more productive than firms without profit sharing although researchers have noted that it is hard to distinguish the effects of profit sharing from other human resource management practices. (Ichniowski, et al., 1997; Kruse, 1993; Weitzman & Kruse, 1990). There are, however, opinions that stock-based compensations may actually hurt corporate performance. Commenting on the executive stock option research tradition, Kevin J. Murphy says that the academic evidence "directly linking current grants to future performance is, frankly, rather flimsy" (Murphy, 1998). One common objection to the positive spin put on stock options is the observation that a firm with a broader stock-based stock compensation plan may experience significant increases in its shareholder value over a certain time period. But if this company is compared to its entire industry group, the story that employees did well and shareholders did well, may be revealed to be a hoax if the company actually did worse than the rest of its industry group. For those reasons, some companies have structured their stock option programs, as described below, so that they assure some type of above average performance (Sesil, et al., 2000): • Some options have a premium price set higher than the market price of the common stock on the date the option is granted and include the possibility that no options will be earned; • Some options will not vest until certain strict performance targets are met by the company; • Some options index their exercise price to a market or industry group average to insure that profit from the options comes as a result of the company’s performance rather than the performance of the market or the firm’s industry group. 23 3.3 The Growth of Stock-Based Compensation Stock options have become a standard part of both executive and non-executive compensation packages. A 1998 Towers Perrin study found that 78% of U.S. companies provide stock options (Orr, 1999). Interestingly, non-top-fiveexecutive employees hold most stock options. A study of large firms over the 1994–1997 time period showed that 75% of stock options are granted to nontop-five employees (Core & Guay, 2001). Over a similar time period, a survey by ShareData found that, of companies with stock options plans and more than 5,000 employees, the percent that grant options to all employees increased from 10 to 45%. In addition, 74% of companies with less than $50 million in sales grant options to all their employees (Morgenson, 1998). According to Corey Rosen, Executive Director of The National Center of Employee Ownership (NCEO), there is no reporting system that could provide a reliable data on how many employees get stock options. So the NCEO has constructed estimates based on a study by the Bureau of Labour Statistics and surveys by a number of large consulting firms, including Mercer Consulting; Hewitt Associates; academics Edward Lawler, Susan Mohrman, and Gerald Ledford; and Segal Sibson, all of which came to compatible conclusions ( From these surveys, it was estimated in the year 2000 approximately 7 to 10 million employees held stock options. But because options are often not granted annually, especially in some very large companies with broad-based grants that does not mean that 7 to 10 million people get options granted to them every year. That number is probably in the range of three million per year. It was estimated that the number of people receiving options in the United States grew dramatically in the 1990s; growth since 1999 probably has levelled off as the tech sector's growth has slowed. In 1992, only about one million people had options. Table 1 below shows estimated growth over time (these numbers represent the number of employees holding options, not the number of employees receiving options in a particular year): Table 1: The Growth of Employee Holding Stock Options in the US. ( Year Number of Employees Holding Stock Options 1992 1,000,000 1993 1,750,000 1994 2,350,000 1995 3,400,000 24 1996 4,000,000 1997 4,000,000 - 5,300,000 1998 5,700,000 - 8,400,000 1999-present 7,000,000 - 10,000,000 3.4 Stock-Based Compensation Plans – Expense or Not? Current accounting practices allow companies to ignore the cost of stock-based compensation in their income statements. Companies are able to grant valuable option packages without affecting their earnings. In the opinion of many, not expensing the stock-based compensation plans leads to overstated earnings, which subsequently leads to higher share prices (Sahlman, 2002). FASB considers...
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This document was uploaded on 10/31/2013.

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