Brown must learn lessons from US-style share option schemes

News Analysis: In today's Budget, the Chancellor will announce plans to double employee share ownership in the UK. But there are pitfalls.
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The Independent Online
WHEN GORDON BROWN announces this afternoon a massive programme to double employee share ownership in Britain, he would do well to distance himself from US-style share option schemes.

While the idea of employee share ownership as an incentive for workforces and as a way of giving them a stake in their companies is all-American in origin, it seems to have gone off the rails in the US as far as stock options are concerned.

Just as Britain embraces more fervently than ever the dream of a shareholding democracy, there is the prospect that the US may be questioning, and even taking action against, the spiralling stock option deals that have created so many millionaires across the Atlantic.

The irony is that the bloated stock option packages for fat cat directors, which have become a target for shareholder activists in America, were the direct result of calls a decade ago by exactly the same constituency for more performance-related pay.

American investors are worried about the impact of share option schemes on share values. Twice as many share option schemes were vetoed in the US last year as in 1997.

Critics charge that what started as an attempt to implement shareholder democracy has ended with a small number of top executives being set easy performance targets and receiving absurdly large rewards.

There is also concern that if all these employees cash in their stock options at the same time, they will drain the company of cash and dilute existing shareholder stakes. The problem has been dubbed "the stock option overhang".

How big the problem really is has provoked a huge row in the US, however. Some researchers claim that 13 per cent of all US shares are destined to be stock options, while others claim the figure is only 7 per cent.

There are also worries that stock option schemes distort company accounts, making corporations impossible to value correctly. The accountancy firm Robson Rhodes published research last year which claimed that the full cost of Microsoft's options scheme, which represents around a fifth of all its shares, would have pushed the software giant into a $10bn loss for 1996 if they had been correctly accounted for.

Annoyingly for the Chancellor, it is hi-tech success stories such as Microsoft that he wants to encourage, but obviously not in this way. The dilemma causes some grim amusement to UK accountants. John Whiting, a tax partner with PricewaterhouseCoopers in London, says: "I'm sure Gordon Brown would love to have a problem like Microsoft."

Microsoft is, perhaps, the classic case of a company balancing low wages with the promise of riches to come from stock options. According to Michael Cusumano and Richard Selby's book Microsoft Secrets, published last year, overall compensation has been generous in the 12 years since the company came to the market due to the steady rise in the shares.

An employee buying $1,000 worth of stock when the company went public would have an investment worth more than $120,000 by the end of 1996. This has led to the creation of thousands of "Microsoft millionaires". Cusumano and Selby put the figure at 3,000 out of a workforce of 17,800 in the mid-1990s.

Bill Gates himself, while taking a relatively modest salary, became the PC industry's first billionaire in 1987, and other big stockholders - Paul Allen and Stephen Ballmer - followed. Microsoft says that about $450m of stock is currently held by some of its 28,000 employees.

Unlike some other companies, Microsoft publishes its employees' share options, vested or unvested, in its annual report, which has the effect of dragging down earnings per share for normal shareholders.

So is Mr Brown wise to pursue the cause of employee share ownership in his Budget today? Gill Nott, chief executive of ProShare, the organisation which promotes share ownership in the UK, says "yes".

The key difference between the Government's plans and the American cult of stock options is that the UK wants to encourage more actual share ownership, says Ms Nott. ProShare has not been anti-option, she says but "we back schemes where people actually acquire shares".

Ms Nott can't see UK companies wanting to import a system where a small number of executives cause a stock option overhang. For a start, the institutions wouldn't have it. "The Association of British Insurers has tough guidelines which companies breach at their peril," she says. "As a rule, no more than 10 per cent of a company's shares should be under option at any one time."

US-style option schemes would also be taxed heavily in the UK, and would go against corporate culture generally, she says. What Mr Brown should be doing is encouraging companies to enable employees to acquire small amounts of shares regularly and over time, perhaps through pre-tax income.

As for US-style stock option overhangs, Ms Nott says: "I can't understand why they [the US institutions] haven't voted against them."

Another reason to worry about embracing US-style share schemes in an effort to emulate Silicon Valley is that a majority of hi-tech start-ups go bust.

John Whiting of PricewaterhouseCoopers says: "The doom-laden scenario is that employees are forced to accept worthless shares instead of being paid in cash. This fear harks back to the Truck Acts of the Victorian era when factory workers were forced to use company tokens to buy their food and clothing in company shops.

Mr Whiting admits this is an extreme example. There is a risk in all share investment, particularly with start-ups. "Perhaps Americans are just more prepared to take that risk," he says.

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