Stock Option Overhang Shareholder Boon or Shareholder Burden

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Stock Option Overhang- Shareholder Boon or
Shareholder Burden?

• Presented by
• Ira T. Kay, Ph.D.
• Practice Director,
• Compensation Consulting

November 13, 2001
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Definition

• 1. Stock Options Overhang All S.O. granted
  S.O. remaining to be granted
• Total Shares Outstanding
• 2. Run-Rate Annual S.O. grant
• or
• Grant Rate Total Shares Outstanding

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Stock Option Overhang Shareholder Boon or
Shareholder Burden

• Theory
• Time Series
• Industry Data
• Overhang and Performance
• Finding the Sweet Spot
• Impact on Volatility, Dividends and Stock
  Repurchases
• Implications

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Theory

• Stock Options Have 2 Countervailing Effects
• Incentive Effect Upward Pressure on Stock
  Prices
• Dilution/Volatility Effect Downward Pressure

Which Effect Will Dominate?
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Incentive Effect vs. Dilution Effect
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Time Series
Incentive Effect Has Dominated
1990
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Growth in Overhang
Same Companies
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Overhang Growth

• 51 of Companies had their overhang decline
• Overhang Growth (1999-2000) and Performance

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Relative Overhang Counts
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Finding the Sweet Spot
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Finding the Sweet Spot
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Finding the Sweet Spot
pharmaceuticals hospitals
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Finding the Sweet Spot
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Do High Overhang Companies Have High Run Rates?
YES!
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Impact on Volatility, Dividends and Stock
Repurchases

• Stock Ownership vs. Stock Options
• Encouraging Excessive Risk?
• The Findings

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Stock Ownership vs. Stock Options
Ownership shares owned by Top 5 Executives as
a percentage of total shares outstanding. Market
Value market value of shares owned in
millions at year end closing price. Ownership
Intensity shares owned by Top 5
Executives/(shares owned shares of options
held.)
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Stock Ownership vs. Stock Options
Dividends yield dividends per share/average
share price. Repurchases dollar value of share
repurchases/market value at the start of the
year. Leverage book value of debt/(book value
of debt book value of equity).

• Dividends yields have decreased dramatically.
• Stock repurchase activity rose sharply before
  leveling off in 1999.
• Stock price volatility has increased.

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Risk and Volatility
1997
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Risk and Volatility
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Management Stock Purchase Plan (MSPP)

• Pre-tax purchase at a discount
• Creates ownership psychology
• Preserves shares vs. options
• Tax/Accounting Advantages
• Can be retentive as well as motivating
• Example
• 100,000 Bonus deferred 100 into MSPP
• 20 discount yields 125,000 worth of stock is
  purchased
• 3 year vesting on discount and appreciation
• Termination rules are very important

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What Will Happen to Overhang?

• Upward Pressures
• Low exercises
• Shrinking Black-Scholes values
• Downward Pressures
• Institutional Investor/Media reaction
• Downward ratchet from declining competitive
  market values
• CEOs have enough options!
• Saturation of all employee grants
• Survivor Bias - (elimination of Dot.coms)
• Stock Option Repricings/Exchanges
• Layoffs

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Implications

• Executive grants will level off
• Overhang will level off
• More Stock Ownership

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