MARKET WATCH Stock Market: Options Seem to Be Coming Home to Roost By GRETCHEN MORGENSON

October 8, 2000

FOR years, stock options granted by the nation's fastest-growing companies have been capitalism's version of a free lunch. Now, with new-economy stocks tumbling, the bill for the meal may be coming due.

In recent years, shares of Dell Computer, Cisco Systems, Microsoft and others zoomed ahead of old-line companies' stocks on the strength of outsized earnings growth. An increasingly large component of that growth came from stock options that are used to pay employees but are not considered an expense. Options, which cost stockholders in share dilution, cost companies nothing to issue and actually save them money on payroll costs. Those savings go to the bottom line, making earnings growth at many companies look artificially high.

Pat McConnell, an accounting analyst at Bear, Stearns, estimates that earnings among the companies in the Standard & Poor's 500-stock index were overstated by 6 percent, on average, last year because of generous option grants. Nobody cared about this earnings illusion while stock prices were rocketing. Now, growth rates are slowing and investors are dumping their former darlings. The Nasdaq composite index lost 8.5 percent last week and is down 17.41 percent for the year.

The trouble is, stock options work as a compensation device only when share prices are rising. When stocks plummet, the options become unexercisable and possibly worthless, and the construct starts to crumble.

Faced with the prospect of worthless stock options, new-economy workers may begin to demand old-economy cash from their employers. That would drive up corporate costs among technology companies  the biggest users of stock options  at exactly the wrong moment, when their operations are slowing.

The industry groups in which options have contributed most handsomely to operating income growth, according to Ms. McConnell, are semiconductor equipment makers, computer networking companies and communications equipment manufacturers. If employees start saying no to options and yes to cash, these industry groups will be hit hardest.

Workers at many companies are feeling the ill effects of underwater options. According to the most recent financial reports available, 40 percent of options held by Amazon.com employees and at least 36 percent of those held by workers at Microsoft are now unexercisable. Almost 16 percent of options held by workers at Dell Computer and perhaps more than that at Lucent Technologies are below the price at which they were issued. Around 14 percent of options held by employees at Intel and Yahoo were issued at prices higher than can be found in the current market.

At Priceline.com, an estimated 28 percent of outstanding options are under water. Priceline's stock fell to $5.19 last week on news that its affiliated WebHouse Club was shutting down because it could not attract fresh capital. Priceline.com shares fetched $104.25 last March.

None of these figures include option grants made this year, which are almost certainly under water. For instance, the figures for Microsoft do not include the annual option grant made to workers on July 31, when the stock closed at $69.81; it is now at $55.19.

Of course, shares in the former highfliers could roar back to refloat employees' option holdings. And many of the options that are currently under water have long lives, giving holders lots of time to await rescue.

But the widespread use of employee stock options is a relatively new phenomenon, and neither investors nor workers have experienced its effects during an economic slowdown or an extended decline in stock prices.

On the upswing, options were a beautiful thing for companies. Unfortunately, in a downturn, a beautiful thing can turn ugly fast.

http://www.nytimes.com/2000/10/08/business/08WATC.html

-- Carl Jenkins (Somewherepress@aol.com), October 08, 2000

Answers

I find this scenario frightening indeed: NASDAQ is now down 17% on the year, of which ONE-HALF of that loss was lAST WEEK.

Think about it.

-- JackW (jpayne@webtv.net), October 08, 2000.