The allure of employee stock options may have waned along with the world’s stock markets, but it hasn’t disappeared. In fact, the decline in equity prices may present employees with the best opportunity in years to reap long-term gains from new grants. “Executives’ knee-jerk reaction is ‘give me more cash,'” says Cheryl Spielman, a partner at Ernst & Young International. “But with the downturn, it could be a better time now for options.”
Companies worldwide are obliging. A Towers Perrin study of compensation practices in 22 countries last June found that corporations are increasingly relying on equity-based incentives to attract and retain employees. It also found that options, widespread in Canada, the United States, and the United Kingdom since the early 1990s, are fast becoming the favorite tool for aligning executive and shareholder interests elsewhere. The fastest growth is occurring in such markets as Germany, Italy, Taiwan, and Singapore. “By 2003, a majority of firms worldwide will have long-term incentive plans,” says Towers Perrin consultant Fabrizio Alcobe-Fierro.
Thanks to U.S. influence, these plans are likely to feature stock option programs rather than stock purchase plans or restricted stock awards. As U.S. businesses have expanded their option plans overseas, they have increased the pressure on local competitors and foreign companies to match their offerings. And as non-U.S. companies have built up or acquired operations in this country, they have been forced to play by American rules. “The level of option compensation in the U.S. is much higher than in our home countries,” says Nigel Hurst, North American vice president of human resources at Netherlands- and U.K.-based Unilever, which acquired Englewood Cliffs, New Jersey-based Bestfoods last year. To remain competitive, the company also issues restricted stock to its U.S. executives.
Like all multinationals, Unilever had to reconcile its pay practices in the United States with those in its home countries and in other markets. The pay level is only the most obvious difference among markets; the tax treatment, regulatory requirements, and cultural perceptions of stock options vary widely. It may make intuitive sense to provide incentives with the same terms to employees wherever they work, but in practice it can be costly and inefficient. “Most companies want to have the same plan across different countries, but you’ve got to build in some flexibility,” says Alcobe-Fierro.
The first issue when implementing an options program is to determine how they are to be granted and exercised. Equity-based incentive programs have two fundamental objectives: to align the interests of managers with shareholders and to pay executives based on how well they perform. In the United States, the “plain vanilla” options that virtually all companies offer are given with no strings attached. Granted at the prevailing market price, the options typically vest in three or four years and allow executives to realize the full increase in the share price above the strike price of the options.
The problem is that share movements alone are a poor indicator of a manager’s performance, says Richard Dobbs, a consultant with McKinsey. A McKinsey analysis of the stocks of some 400 companies determined that since 1962, more than 40 percent of stock returns for the average company in any one-to-three-year period are attributable to movements in the stock of other companies in its sector and of the market as a whole. During the late, great bull market, even inept managers realized option windfalls that had little to do with performance.
A solution increasingly being embraced by European multinationals is to define criteria that isolate company share performance from stock price movements in the rest of the market. German chemical company BASF AG has undertaken one of the more creative plans to accomplish this. Each of the company’s top 800 executives in the plan is required to make an investment in BASF stock. “A major issue for our CEO and supervisory board was that executives had to bring some of their own money to the table,” says Robert Thomas, director of compensation and benefits. Eligible participants can invest between 10 percent and 30 percent of their variable compensation to buy shares at the market price the day after the annual shareholder meeting. The employee then receives four options per purchased share, each with two (A+B) subscription rights. Both rights vest after two years and can be exercised over the following six years, but BASF has designed both absolute and relative performance hurdles that determine how the options can be exercised. The A rights can be exercised as long as BASF stock appreciates at least 30 percent from the day the options were granted. The B rights provide participants with a relative hurdle: for every percentage point BASF stock outperforms the Dow Jones Global Chemical Index, holders can purchase shares at a discount of 2 percent from the market price when the options were granted. If both hurdles are met, an executive can exercise one option and get two shares.
While plan terms can be standardized worldwide, no two countries have the same tax rules and regulatory requirements for option compensation. Even within the European Union, rules for withholding taxes for options grants vary widely. Despite the oft-stated ambition of the European Commission to harmonize those rules, compensation managers aren’t holding their breath. “It certainly would help,” says Simon Zinger, vice president at Vivendi Universal. “But I’m not optimistic.”
Like other companies with employees across the EU, Vivendi often has to tweak its two plans (one covering the top 200 executives, the other about 4,000 midlevel managers) to suit local circumstances. In France, where Vivendi is headquartered, if employees exercise and sell options within four years of their grant, they are liable for a 40 percent social tax on the benefit. What’s more, Vivendi has to make its own tax payment. Not surprisingly, the French employees must wait at least four years before exercising options.
In other countries, the rules are even more onerous. The Belgian government, for example, taxes stock options when they are granted, which often results in a big tax bill for employees years before they exercise the options. Cisco Systems Inc., which grants options to all its employees, facilitates loans through a third party to its 455 Belgian workers to help cover the taxes. The employees repay the loans when they exercise the options. “We don’t want employees turning down their option grants,” says Roxanne Povio, international stock option plan administrator.
Elsewhere, however, taxes are the least of the problems when it comes to stock options. Countries such as India, Brazil, and South Africa, for example, don’t like currency going offshore to purchase shares of a foreign parent. And in China and Russia, fuzzy regulations can make it risky for multinationals to issue options. Intel (which grants options to all employees where permitted) uses “in lieu of stock option programs” in countries where delivering options is problematic. Employees don’t actually receive Intel shares, but are able to benefit from comparable programs. “We keep our employees close to the share price,” says Brad Stevens, corporate compensation and benefits manager.
Local or Global?
Despite the trouble spots, most multinationals say they take a global view of benefits administration, including stock options. According to another survey by Towers Perrin, a worldwide approach to managing employees’ benefits aids in cost control (50 percent of respondents) and in effectively recruiting and retaining employees (44 percent).
For some companies, such as BASF, that translates into a one-size-fits-all options policy. The only special concession BASF makes in the United States is to offer the plan deeper into management ranks. And India-based software maker Wipro Ltd. offers the same plan–plain vanilla options based on employees’ past work performance, potential, and market value of their skills–across its markets, says Raja Veluswamy, talent engagement and development manager. “The differences are in the number of options granted, not the features.”
Still, given the different tax rules, regulations, and cultural perceptions of equity-linked incentives, many companies tailor their plans to individual markets. “The idea of one plan that treats everyone the same is very American,” says Carine Schneider, a partner at PricewaterhouseCoopers. Which doesn’t make it bad, of course. But for the time being, she says, global option plans are likely to incorporate a lot of local flavor.
Sidebar: Automating Options
Once the number of employees in a stock option plan exceeds 100, the task of tracking grants, vesting schedules, and exercises can be a nightmare. Many companies outsource the job to banks or stock plan administrators like Jersey Island-based Abacus Corporate Services, whose customer base has grown from 6 to 160 in the past five years.
Large companies are also setting up corporate Web sites and using specialized software to provide online accounts. The software enables employees to get information on their options and construct “what if” scenarios. “It eliminates an enormous amount of administrative work and telephone calls,” says Tom Waldron, IT manager for the legal department of American Insurance Group. To track AIG’s options, Waldron uses ExpressOptions from Transcentive Inc., which costs from $15,000 to $150,000 annually, depending on the number of users. The other major software provider, EquityEdge, is owned by online broker E-Trade.
Both offerings are oriented to the U.S. market. But Transcentive, in concert with Ernst & Young, is developing a new product for dealing with the tax and legal regimes in different markets. The product, tentatively priced at $75,000 to $350,000 annually depending on the size of the plan and other factors, is scheduled to begin beta testing this spring.