Microsoft to end stock options

Microsoft Corp. will stop giving its employees stock options, halting a practice that transformed thousands of them into millionaires and reshaped the regional economy.

Beginning in September, employees will receive shares of Microsoft stock, rather than options to buy them, the company said yesterday. Microsoft expects the shift to help it attract and retain employees by putting more financial certainty into their overall compensation.

The decision marks the end of an era for the company's employees and for the Seattle region. No more will Microsoft's employees become overnight millionaires by cashing in on their stock options. Nor will the region's economy enjoy the effects of that phenomenon.

But the change is a positive one for many employees whose stock options were rendered worthless when the company's share price fell with the rest of the stock market.

Under the new program, employees will get fewer shares of the company than they would have been given the option to buy under the old program. As a result, if Microsoft's stock price rises dramatically at some point, the employees won't realize as much profit as they would have with stock options.

Microsoft "agonized over that," said Ira Kay, director of the compensation consulting practice at Watson Wyatt Worldwide in New York, who advised Microsoft as it developed the new policy. "If there's a bull market, they'll have made an error, and if there is continuing, gentle stock price appreciation, they'll look like geniuses," he said. He called the bull-market scenario "highly unlikely."

Microsoft executives agreed.

"The price has to rise pretty dramatically (for that to happen), to the point that you're getting to bubble-era stock prices," said John Connors, Microsoft's chief financial officer. "We don't anticipate that kind of abnormal market behavior any time soon."

For all practical purposes, in fact, the era of stock-option riches ended, at least for the time being, with the deflating of that technology stock bubble three years ago. The awarding of actual stock, rather than options, reflects that new reality.

"The employees will be guaranteed some value in the end," said Seattle economist Dick Conway, "whereas on the stock-option program it's really a game of dice, with potential for big gains but also, as we've seen the past few years, potential for no gain."

That downside came from the way stock options work. Options let employees purchase stock at a fixed price at a future date. If the market price for the stock rises prior to that date, employees can realize a profit by buying at the fixed price and selling at the market price. If the market price of the stock falls below the fixed price, however, the options are rendered worthless.

Some employees have also ended up in bankruptcy after borrowing against their options and making other financial missteps.

The company realized some sort of change was necessary after employee surveys identified a significant amount of "angst" over the issue of stock options, said Steve Ballmer, the company's chief executive officer.

The change results from more than a year of work by company executives, incorporating feedback from employees who participated in focus groups. The company, which employs more than 26,000 people in the Puget Sound region and more than 54,000 worldwide, announced the changes to employees in a webcast yesterday.

They greeted the news with mixed emotions. Some liked the idea of receiving a relatively predictable equity stake in the company as part of their compensation package, even though the new program doesn't hold quite the same promise of huge returns.

Other saw in the departure from stock options a larger signal about Microsoft's evolution.

"It's a big move away from what Microsoft was as a company," said employee Brandon Dow. "Microsoft is resigning itself to being a good, solid company, but not in the maverick sense, with the potential of a huge upside."

Yet Dow said he also appreciates the near-term value of the change for employees such as himself. Currently a lab manager for the Windows CE operating system, he became a full-time Microsoft employee in February 2000, shortly before the stock market slumped. As a result, he hasn't yet seen any benefit from his stock options.

As part of the changes, Microsoft also said it would begin reporting the stock it awards as an expense on its financial statements. The company had resisted the movement toward counting stock options as an expense.

The switch to the new stock program necessitates the accounting change, Ballmer said. The effect of the new program, from a shareholder's perspective, should be neutral, he said.

"We're not trying to make some cosmic statement about what policy should be," he said. "We're not using stock options anymore, so in some senses we're isolated now from the debate about whether stock options should be expensed or not."

Ballmer and Microsoft Chairman Bill Gates won't be given stock under the new program, just as they didn't receive stock options under the old program, the company said.

As part of the changes, however, the company plans to award stock to about 600 top executives. The amount will be determined for executives based on measures of their progress in satisfying and attracting customers.

Stock will be awarded to employees upon their arrival at the company and periodically thereafter, just as stock options were. Each stock award will vest, or become owned by the employee, at a pace of 20 percent over a period five years.

Microsoft declined to disclose how much stock the average employee will receive under the new plan, saying it will vary widely depending on an employee's position and performance.

In addition, the company is talking with investment bank JP Morgan Chase to set up a program that would allow employees to sell options for which the established purchase price is significantly higher than the current market price, allowing them to realize at least some value from those options, Ballmer said.

P-I reporters John Cook and Paul Nyhan contributed to this report. P-I reporter Todd Bishop can be reached at 206-448-8221 or toddbishop@seattlepi.com.

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