[Congressional Record Volume 143, Number 44 (Tuesday, April 15, 1997)]
[Senate]
[Pages S3202-S3206]
From the Congressional Record Online through the Government Publishing Office [www.gpo.gov]

      By Mr. LEVIN (for himself and Mr. McCain):
  S. 576. A bill to amend the Internal Revenue Code of 1986 to provide 
that corporate tax benefits from stock option compensation expenses are 
allowed only to the extent such expenses are included in corporate 
accounts; to the Committee on Finance.


           THE ENDING DOUBLE STANDARDS FOR STOCK OPTIONS ACT

  Mr. LEVIN. Mr. President, for the past several years, the Wall Street 
Journal has published a special pullout section of the newspaper with a 
number of articles on executive pay. Last year's headline read, ``The 
Great Divide: CEO Pay Keeps Soaring Leaving Everybody Else Further and 
Further Behind.'' Last week, Business Week magazine featured this cover 
story on its 47th annual pay survey: ``Executive Pay: It's Out of 
Control.''
  Both publications analyze the pay of top executives at approximately 
350 U.S. major corporations. Their analysis shows that the pay of the 
chief executive officers continues to outpace inflation, other workers' 
pay, the pay of CEO's in other countries, and company profits.
  According to Business Week, for CEO's of the leading 350 companies 
studied, their average total compensation rose 54 percent last year to 
about $5.7 million, which came on top of 1995 CEO pay increases of 30 
percent. So in 1995 we had the CEO's increasing their pay by 30 
percent, last year increases of 54 percent. Blue-collar employees 
received a 3 percent raise in 1996, and white-collar workers fared only 
slightly better with a 3.2 percent raise.
  So in 1996 the pay of the top executives was 209 times the pay of the 
factory employee, which is a huge increase. The ratio of executive pay 
to factory workers' pay in the United States was already two to three 
times more than the pay ratio in any other country. Suddenly, now we 
see this going up to a ratio of 209 times the pay of the average 
factory worker. The last time we had statistics, the ratio of executive 
pay to factory worker pay was 20 times in Japan and 25 times in 
Germany. Those statistics are a few years

[[Page S3203]]

old but we do not think they have changed that much.
  These statistics, the 3.2 percent pay increase that went to the white 
collar workers and the 3 percent increase in wages and benefits that 
went to America's blue collar workers, represent a growing problem in 
America, and represent a gap that is growing. The question is now what? 
Is this gap going to continue? That is a question more for the market 
than for government.
  There is something that government is currently doing that can change 
this, and that is right now we permit stock options, which represent 
the biggest portion of corporate pay, to be taken as a tax deduction 
for income tax purposes, although it is not shown as an expense on the 
company's books. There is no other form of executive compensation for 
which this is true. Every other form of executive compensation, of 
compensation for anybody, is shown as an expense on the company's books 
when it is taken as a deduction on income tax.
  There is no double standard for any form of compensation in our 
country, in our Tax Code, except for stock options. If a corporate 
executive gets stock, that is an expense on the company's books. It is 
a tax deduction on their income taxes. If there is a bonus based on 
performance, that is an expense on the company's books, and it is a tax 
deduction. But when it comes to stock options, the Tax Code right now 
permits there to be a tax deduction for the company when that stock 
option is exercised. However, the company does not show that stock 
option as an expense on its own books. It is a stealth exception. It is 
a double standard. We should end it.
  That is why, today, Senator McCain and I are introducing legislation 
to end this corporate tax loophole that is fueling the increases in 
executive pay and is fueling those increases with taxpayer dollars. 
Again, this loophole allows companies to deduct from their income taxes 
these multimillion dollar pay expenses that never show up on the 
company office books as an expense.
  A just completed survey of CEO pay at 55 major Fortune 500 
corporations by a leading executive compensation publication called 
Executive Compensation Reports, found that in 1996 stock options 
averaged about 45 percent of total executive pay. That is up from 40 
percent just 1 year ago, and stock options provided more money to the 
55 CEO's studied than their base salary or their annual bonus. In fact, 
for 1996, salary accounted for only 22 percent of CEO compensation 
while stock options accounted for 45 percent.

  These stock options enable a CEO typically to buy company shares at a 
set price for a period of time, which is usually 10 years. Since stock 
prices generally rise over time, stock options have become the most 
lucrative source of executive pay.
  Now, again, I do not think anyone is suggesting government ought to 
determine how much executives get paid. We should not. Stockholders and 
boards of directors should set that. But we should determine whether or 
not we want to allow our Tax Code to contain this loophole any longer, 
where this one form of executive compensation and only this form of 
compensation is dealt with by a double standard. We permit the company 
to get the tax deduction when it comes to filing their income tax 
return, but we do not require the company to show that same expense as 
an expense on their books, thereby hiding the cost to the company of 
the stock option cost but still getting a tax deduction.
  Now, say, a corporate executive exercises stock options to purchase 
company stock and makes a profit of $10 million. The company can claim 
the full $10 million as a business expense and deduct it from the 
company's tax bill. But when it comes to showing that expense on their 
books, on their annual report, it is not an expense. It is a footnote, 
not required to be shown as an expense like other forms of 
compensation, but rather hidden in a footnote.
  This is not an accounting issue. The accounting authorities, the 
experts, have decided how this should be handled as an accounting 
matter. This is now a tax loophole issue. The question is whether or 
not we, on tax day, want to continue a loophole for executives--because 
that is who we are talking about in approximately 98 percent of the 
cases. In perhaps 1 or 2 percent of the cases these stock option plans 
are broadly based and help average employees, and we would not include 
that in our bill. But in maybe 98 percent of the cases, these are 
narrowly based stock option plans only going to the top officials of 
companies.
  This bill would end the double standard. It gives a choice. If you 
want to take it as an expense for tax purposes, deduct this as 
compensation for tax purposes, that is fine, no restriction. But then 
you have to show it on your books as an expense also. You do not want 
to show it on your books as an expense? That is your choice, but then 
we will not let you take it as an expense on your income taxes and have 
the rest of the taxpayers of the United States foot the bill.
  Stock option pay is either a company expense or it is not. It either 
lowers company earnings or it does not. Something is clearly out of 
whack when in the tax law a company can say one thing at tax time and 
something else to investors at the annual meeting.
  This bill that I am introducing with Senator McCain today would end 
the double standard that allows corporations to treat stock option pay 
one way on the tax form and the opposite way on the company's books.
  I want to emphasize that this bill does not prohibit stock options. 
It doesn't put a cap on them. It doesn't limit them in any way. It just 
says, if you want to claim stock option pay as an expense at tax time, 
you have to treat it as an expense the rest of the year as well.
  In summary, the bill would not prohibit stock options. It would not 
put a cap on them or limit them in any way. It just says, if a company 
wants to claim stock option pay as an expense at tax time, it has to 
treat it as an expense the rest of the year as well. Period.
  The bill provides one exception to ensure that closing the stock 
option tax loophole doesn't affect the pay of average workers.
  Right now, stock option pay is overwhelmingly executive pay. In 1994, 
the most extensive stock option review to date, covering 6,000 publicly 
traded U.S. companies, found that only 1 percent of the companies 
issued stock options to anyone other than management and 97 percent of 
the stock options issued went to 15 or fewer individuals per company.
  Nevertheless, there are a few companies that issue stock options to 
all employees and do not disproportionately favor top executives. Our 
bill would allow companies that provide broad-based plans to continue 
to claim existing stock option tax benefits, even if they exclude stock 
option pay expenses from their books. Like FASB, we would encourage but 
not require these companies to treat these expenses consistently. By 
making this limited exception, we would ensure that average worker pay 
would not be affected by closing the stock option loophole. We might 
even encourage a few more companies to share stock option benefits with 
average workers.
  The bottom line is that the bill that Senator McCain and I are 
introducing today is not intended to stop the use of stock options. Our 
bill is aimed only at stopping the manipulation of stock option 
expenses by those companies that are trying to have it both ways--
claiming stock option pay as an expense at tax time, but not when 
reporting company earnings to Wall Street and the public. It is aimed 
at ending a stealth tax benefit that is fueling the wage gap, favoring 
one group of companies over another, and feeding public cynicism about 
the fairness of the Federal Tax Code.
  It would also curtail an expensive tax loophole. The Congressional 
Budget Office has estimated that eliminating the corporate stock option 
loophole would save taxpayers $373 million over 7 years and $933 
million--almost $1 billion--over 10 years. In this era of fiscal 
austerity, that's money worth saving.
  Mr. President, I ask unanimous consent that the bill Senator McCain 
and I are introducing be printed in the Record, along with a section-
by-section analysis of the bill that would end the double standards for 
stock options.
  There being no objection, the material was ordered to be printed in 
the Record, as follows:

                                 S. 576

       Be it enacted by the Senate and House of Representatives of 
     the United States of America in Congress assembled,

[[Page S3204]]

     SECTION 1. SHORT TITLE.

       This Act may be cited as the ``Ending Double Standards for 
     Stock Options Act''.

     SEC. 2. REQUIREMENTS FOR CONSISTENT TREATMENT OF STOCK 
                   OPTIONS BY CORPORATIONS

       (a) Consistent Treatment for Tax Deduction.--Section 83(h) 
     of the Internal Revenue Code of 1986 (relating to deduction 
     of employer) is amended by adding at the end the following 
     new paragraph:
       ``(2) Special rules for property transferred pursuant to 
     stock options.--
       ``(A) In general.--In the case of property transferred in 
     connection with a stock option, the deduction otherwise 
     allowable under paragraph (1) shall not exceed the amount the 
     taxpayer has treated as an expense for the purpose of 
     ascertaining income, profit, or loss in a report or statement 
     to shareholders, partners, or other proprietors (or to 
     beneficiaries). In no event shall such deduction be allowed 
     before the taxable year described in paragraph (1).
       ``(B) Exception for broad-based option programs.--
     Subparagraph (A) shall not apply to property transferred in 
     connection with a stock option if, at the time the stock 
     option was granted--
       ``(i) substantially all employees of the corporation 
     issuing such stock option were eligible to receive 
     substantially similar stock options from such corporation,
       ``(ii) no individual performing services for such 
     corporation received more than 20 percent of the total number 
     of stock options granted by such corporation during the 
     taxable year, and
       ``(iii) at least 50 percent of the total number of stock 
     options granted by such corporation during such taxable year 
     were issued to employees other than individuals performing 
     executive or management services for such corporation.
       ``(C) Employees covered.--For purposes of this paragraph, 
     an employee shall be taken into account only if--
       ``(i) the employee is a full-time employee, and
       ``(ii) substantially all of the services performed by the 
     employee for the corporation are performed within the United 
     States.
       ``(D) Special rules for controlled groups.--The Secretary 
     shall prescribe rules for the application of this paragraph 
     in cases where the stock option is granted by a parent or 
     subsidiary corporation (within the meaning of section 424) of 
     the employer corporation.''
       (b) Consistent Treatment for Research Tax Credit.--Section 
     41(b)(2)(D) of the Internal Revenue Code of 1986 (defining 
     wages for purposes of credit for increasing research 
     expenses) is amended by inserting at the end the following 
     new clause:
       ``(iv) Special rule for stock options and stock-based 
     plans.--The term `wages' shall not include any amount of 
     property transferred in connection with a stock option and 
     required to be included in a report or statement under 
     section 83(h)(2) until it is so included, and the portion of 
     such amount which may be treated as wages for a taxable year 
     shall not exceed the amount of the deduction allowed under 
     section 83(h) for such taxable year with respect to such 
     amount.''
       (c) Conforming Amendments.--Section 83(h) of the Internal 
     Revenue Code of 1986 is amended by striking ``In the case 
     of'' and inserting:
       ``(1) In general.--In the case of''.
       (d) Effective Date.--The amendments made by this section 
     shall apply to property transferred and wages provided on or 
     after the date of enactment of this Act, pursuant to stock 
     options granted on or after such date.
                                                                    ____


   Section-by-Section Analysis of Ending Double Standards for Stock 
                              Options Act

       Short Title. Section 1 of the bill provides the short 
     title.
       Consistent Treatment. Section 2 of the bill would establish 
     requirements for consistent treatment of stock options by 
     corporations when deducting stock option compensation as a 
     business expense under Section 83(h) or claiming stock option 
     wages to obtain a research tax credit under Section 41.
       Tax Deduction. Subsection 2(a) of the bill would amend 
     section 83(h) of the Internal Revenue Code by adding at the 
     end a new paragraph (2) with special rules for corporate tax 
     deductions related to stock options. A new subparagraph 2(A) 
     of Section 83(h) would limit the deduction that a company 
     could claim for stock option compensation to no more than the 
     amount of stock option expense reported by that company in a 
     financial statement to stockholders. The subsection would 
     continue current law by allowing the deduction at the time 
     the stock option beneficiary exercises the option and 
     includes it in personal income.
       Average Workers Protected. A new subparagraph 2(B) of 
     Section 83(h) would establish an exception for stock option 
     plans that benefit average workers. To qualify, substantially 
     all full-time, U.S. employees in a company would have to be 
     eligible to receive substantially similar company stock 
     options during the taxable year; no one person could have 
     received more than 20 percent of the stock options issued 
     during the year; and at least 50 percent of the stock options 
     would have had to be issued to non-management employees 
     during the year. A new subparagraph 2(C) would state that 
     only full-time employees performing services in the United 
     States would need to be taken into account in determining 
     eligibility for the exception.
       Controlled Groups. A new subparagraph 2(D) of Section 83(h) 
     would authorize the Secretary of the Treasury to issue 
     regulations applying these rules to stock options granted by 
     a parent or subsidiary corporation of the employer 
     corporation.
       Tax Credit. Subsection (b) of the bill would amend Section 
     41 of the Internal Revenue Code to clarify the ``wages'' that 
     may be used in calculating the research tax credit allowable 
     under Section 41. The bill would add a new clause (iv) at the 
     end of Section 41(b)(2)(D) stating that the allowable 
     ``wages'' under Section 41 shall not include stock option 
     compensation, until a company reports that compensation in a 
     financial statement to stockholders, as provided in Section 
     83(h)(2) (as amended by this bill). The clause would limit 
     the amount of stock option compensation allowed as a 
     deduction under Section 83(h). Stock option wages could be 
     claimed under Section 41 only after a company reported the 
     compensation expense under Section 83(h)(2), as amended by 
     this bill.
       Conforming Amendment. Section (c) of the bill would make 
     technical conforming amendments to Section 83(h).
       Effective Date. Section (d) of the bill would make the 
     amendments applicable only to stock options granted on or 
     after the date of enactment.

  Mr. McCAIN. Mr. President, I rise today to introduce legislation with 
my friend and colleague, Senator Levin, entitled Ending Double 
Standards for Stock Options Act. This legislation requires companies to 
treat stock options for highly paid executives as an expense for 
bookkeeping purposes if they want to claim this expense as a deduction 
for tax purposes.
  Currently, corporations can hide these multimillion-dollar executive 
compensation plans from their stockholders or other investors because 
these plans are not counted as an expense when calculating company 
earnings. Even the Federal Accounting Standards Board [FASB] recognized 
that stock options should be treated as an expense for accounting 
purposes. This month, new accounting disclosure rules issued by FASB 
require that companies include in their annual reports a footnote 
disclosing what the company's net earnings would have been if stock 
option plans were treated as an expense.
  An article in the Wall Street Journal, dated January 14, 1997, stated 
these new rules could reduce some companies' annual earnings by as much 
as 11 to 32 percent. One might reasonably ask how an arcane accounting 
rule could have such a large effect on the bottom line of corporations. 
The answer lies in the growth and value of stock options as a means of 
executive compensation. These plans now account for about one-fourth of 
total executive compensation.
  We all have heard the reports of executives making multimillion-
dollar salaries, while average worker salaries stagnate or fall. 
Recently, The Washington Post reported that Michael Eisner, the CEO of 
Disney, was given a stock option package estimated to be worth as much 
as $771 million over the next 10 years. Why shouldn't the value of this 
compensation package be included in calculating Disney's earnings? How 
can stockholders evaluate the true value of executive compensation if 
the value is just buried in a footnote somewhere in the annual report?
  No other type of compensation gets treated as an expense for tax 
purposes, without also being treated as an expense on the company 
books. This double standard is exactly the kind of inequitable 
corporate benefit that makes the American people irate and must be 
eliminated. If companies do not want to fully disclose on their books 
how much they are compensating their executives, then they should not 
be able to claim a tax benefit for it.
  This legislation does not require a particular accounting treatment; 
the accounting decision is left to the company. This legislation simply 
requires companies to treat stock options the same way for both 
accounting and tax purposes.
  I hope my colleagues will join in cosponsoring this important 
legislation that will end the double standard for executive stock 
option compensation.
  I ask unanimous consent that the two articles to which I have 
referred be printed in the Record.
  There being no objection, the articles were ordered to be printed in 
the Record, as follows:

             [From the Wall Street Journal, Jan. 14, 1997]

    As Options Proliferate, Investors Question Effect on Bottom Line

                           (By Laura Jereski)

       How much does Microsoft Corp. really earn from its 
     business?

[[Page S3205]]

       For the fiscal year ended June 30, the Redmond, Wash., 
     software giant said pretax income rose 56% to a record $3.4 
     billion. But a telltale footnote to its income statement 
     revealed that pretax earnings would have been $2.8 billion--
     $570 million less--if Microsoft had compensated its employees 
     entirely with cash.
       But employees didn't get just cash. Like many companies 
     these days, Microsoft sprinkles stock options liberally among 
     its workers. That makes a big difference in the earnings 
     outlook at Microsoft and elsewhere.
       Wall Street and Main Street fervently embrace options as a 
     tonic for much of what ails corporate America. Lucrative for 
     employees, options appear to be cost-free to the employer. 
     Distribute them broadly, the wisdom goes, and employees will 
     pull together, company returns will rocket and shareholders 
     will cheer.
       But some investors and critics say the options downpour is 
     muddying companies' earnings pictures. Companies can show 
     investors higher earnings if they slash compensation costs by 
     handing out options. As Byron Wien, Morgan Stanley & Co.'s 
     top stock-market strategist, points out: ``In the short run, 
     people are overstating current earnings because part of 
     employees' compensation is coming in the form of options.''


                        bet on growth prospects

       Put another way: Investors may be making a bigger bet on 
     company growth prospects than they realize. If Microsoft's 
     options were treated as an expense, its net income last year 
     would have been about $1.8 billion, or $2.85 a share, instead 
     of $2.2 billion, or $3.43 a share--meaning its $83.75 closing 
     stock price on the Nasdaq Stock Market yesterday would 
     reflect an earning multiple of nearly 30 times last year's 
     earnings instead of about 24 times.
       Michael Brown, Microsoft's chief financial officer, scoffs 
     at that notion: ``The Street figures it our pretty fast.''
       But disparities will be popping up all over come March when 
     new accounting disclosure rules by the Financial Accounting 
     Standards Board take effect. For the first time, companies 
     will have to include a footnote in their annual reports 
     disclosing what net would have been if options were treated 
     as an expense--something Microsoft and some others are 
     already doing. Murray Akresh, a compensation expert with 
     Coopers & Lybrand, says the earnings difference could be as 
     much as 11% for some companies. By the time the full impact 
     of the new rule is felt at the end of a four-year transition 
     period, the difference could reach 32%.
       Companies' true earning power is of particular concern 
     because earnings growth has propelled the stock market's 
     sustained rise. But some money managers say that rise is 
     making options more costly for companies to issue.
       ``What's really happening is that companies are selling 
     their stock to employees at a discount,'' says Richard 
     Howard, a mutual-fund manager at T. Rowe Price Associates in 
     Baltimore. Often, the companies then turn around and buy 
     stock at the higher market price to hold steady the number of 
     shares outstanding.
       ``There's a real economic cost when stocks are going up,'' 
     Mr. Howard says. ``That's when options cost the most.''


                           options have value

       One measure of that aggregate cost can be seen in stock-
     buyback programs. In 1996, buybacks totaled $170 billion, 
     according to Securities Data Co., a Newark, N.J., securities-
     market-data company, up 72% from the previous year's $99 
     billion. Buyback costs are partly offset by the money 
     companies collect from employees who exercise their options 
     and buy.
       Some investors say the costs ought to be reflected in 
     companies' income statements at the time the employees earn 
     the options. ``Stock options have value, so they should be 
     recorded as an expense,'' says Jerry White, president of 
     Grace & White, a New York money-management firm.
       And some shareholder activists are rebelling against the 
     amount of options being dispensed. Institutional Shareholders 
     Services, which votes on shareholder issues on behalf of many 
     large investors, votes against about one in five option plans 
     as too generous and expensive. Says ISS research director 
     Jill Lyons: ``A human being has to say, `This is too much.' 
     ''
       ISS focuses on how much shareholder value option plans 
     transfer, rather than how they might affect company earnings. 
     For example, a magnanimous plan adopted two months ago by San 
     Jose, Calif., computer networker Cisco Systems Inc. will set 
     aside 4.75% of Cisco's stock for options annually for three 
     years. Three-fourths of those options will go to employees 
     below the vice-president level.
       Most of Wall Street applauds this employee motivator. 
     Analyst Suzanne Harvey at Prudential Securities wrote 
     recently that Cisco has the best employee benefits in the 
     computer industry.
       But ISS analyst Caroline Kim warned clients that the option 
     plan would double insiders' stake in Cisco to nearly 23%--
     twice what employees in comparable companies get--and hand 
     over to employees shareholder value of $3.6 billion during 
     the next three years. Shareholders approved the plan anyway.
       Many investors and financial analysts see nothing wrong 
     with companies' generosity with options. In a recent survey 
     of 300 top Wall Street stock analysts, eight of 10 said they 
     would disregard stock options entirely, as long as companies 
     don't have to take a charge for them. ``I think that's 
     accounting mumbo jumbo, as opposed to a value measure that 
     has to do with stock prices,'' says Bruce Lupatkin, head of 
     research at Hambrecht & Quist.
       That view prevailed in 1995, after a long and bruising 
     battle over whether such options largess should count against 
     earnings. Hundreds of companies, analysts, venture 
     capitalists, and even congressmen joined forces to defeat 
     accounting rule makers who wanted companies to reflect the 
     actual value of options in their earnings. When the FASB held 
     hearings on the proposal in Silicon Valley--where such 
     options have created thousands of fortunes--they were 
     disrupted by a ``Rally in the Valley'' of the local 
     citizenry, complete with marching bands, balloons and T-
     shirts stamped ``Stop the FASB.''


                            more widespread

       FASB opponents argued that companies incur no cash costs in 
     granting options. Further, not all options granted will be 
     exercised since employees leave and stock prices sometimes 
     fall below the option exercise price. The FASB accountants 
     argued that options are valuable because they give employees 
     a long-term right to buy stock at a set price. They lost, 
     which led to the compromise with the footnote disclosure.
       Since then, option grants have become more generous and 
     more widespread. Once they were mainly used by small, fast-
     growing high-technology companies loath to part with precious 
     cash. Today, big companies are enthusiasts, according to a 
     survey of 350 large companies by William M. Mercer Inc., a 
     New York compensation-consulting firm. Annual stock-option 
     grants soared by more than 20% between 1993 and 1995, the 
     firm's work shows.
       John McMillin, a food-industry analyst at Prudential 
     Securities, says that means ``the quality of the earnings you 
     are looking at is often not good.'' What's more, some 
     companies offer employees the chance to take raises and pay-
     related benefits in stock instead of cash, which distorts 
     earnings even more. (That can be a losing bet for the 
     employee if the stock fails to rise above the exercise 
     price.)
       One big proponent of options-for-all is General Mills Inc. 
     The Minneapolis cereal and baked-goods company started 
     granting options to all employees in 1993. General Mills had 
     already been offering its top 800 people the opportunity to 
     take raises and some other benefits in options instead of 
     cash.
       Mike Davis, General Mills' compensation vice president, 
     says the option programs are ``very attractive for 
     shareholders'' because they cut fixed costs and thereby boost 
     profits, though he can't say by how much. One clue: The 
     company's selling, general and administrative expenses, which 
     include compensation, dropped by $222 million, or 9%, to $2.1 
     billion, in May 1996, compared with May 1994. For that same 
     period, pretax earnings from continuing operations rose $194 
     million, or 34%, to $759 million.
       Meantime, General Mills' options grants have been steadily 
     ratcheting up. Today, the company distributes almost 3% of 
     its stock to employees annually, buying enough stock to match 
     that distribution. ``They are working hard to keep the 
     shares-outstanding line flat,'' Mr. McMillin of Prudential 
     says. ``That also means that they have to go into the market 
     arbitrarily, as options are exercised, and buy stock back at 
     a higher level.''
       Microsoft, to some extent, also uses buybacks to offset 
     option grants, says, Mr. Brown, its chief financial 
     officer. But the buybacks have become so expensive that 
     the company had to invent a new security to help offset 
     the cost. ``The impact of buying back shares has been more 
     extreme for them because the price took off so 
     dramatically,'' says Michael Kwatinetz, a stock analyst 
     who covers the company for Deutsche Morgan Grenfell. 
     Still, Mr. Kwatinetz views the options package overall as 
     ``a strong plus'' for employees.
       For a while, Microcsoft was coming out about even, in real 
     money terms. When employees exercise options for, say, $40 a 
     share, they pay Microsoft the exercise price. Microsoft gets 
     a tax deduction for the difference between the exercise price 
     and the market price.


                            no small change

       But the gross buyback cost has been rising, to $1.3 billion 
     last year from $348 million in 1994. Employees paid Microsoft 
     about $500 million last year for their stock, and tax savings 
     further reduced the company's out-of-pocket costs. But 
     Microsoft still had to shell out about $300 million.
       Compared with the $570 million in options expense, that 
     sounds like Microsoft is getting its money's worth. In fact, 
     the company is actually paying out $400 million in real cash, 
     to offset employee stock options whose cost isn't recognized 
     in its financial statements.
       Still, $400 million is no small change, even for a company 
     as flush as Microsoft. So in December, the company sold $1 
     billion of a newfangled convertible-preferred stock to 
     outside investors that will reduce such costs as long as the 
     stock rises more than 6.88% a year for the next three years. 
     (The preferred stock, which will be redeemed at as high as 
     $102.24 a share, can be exchanged for cash, debt or stock. If 
     Microsoft's stock price falls, the preferred would be 
     redeemed at no less than $79.875 a share.)
       Many investors consider the financial impact of the options 
     by focusing on earnings per share on a fully diluted basis, a 
     calculation that assumes that options outstanding

[[Page S3206]]

     at prices below the current market have been exercised. Tom 
     Stern at Chieftain Capital, a New York money manager, goes 
     one step further. He estimates how much the stock ought to 
     rise, if his earnings estimates are right, and figures out 
     how many more options will be exercised. ``We pay close 
     attention to options,'' he says. ``If you don't, your 
     earnings get diluted.''
       Will the required footnote disclosure in companies' annual 
     reports have a big impact? ``That's not chopped liver,'' says 
     Jack Ciesielski, author of the Analyst's Accounting Observer 
     newsletter. ``I don't think investors have any idea how big 
     the options programs are.''
       To calculate the cost, many companies will use option-
     pricing models in wide use on Wall Street that combine the 
     time span of the options with the volatility of each 
     company's stock price. Options in a hightech company tend to 
     be worth more since chances are better the stock will surge.
       A few companies have already bit the bullet. Bristol-Myers 
     Squibb Co., the New York pharmaceuticals concern, revealed 
     last year that its options plan would have trimmed 1995 net 
     by a mere $35 million, cutting seven cents a share from per 
     share earnings of $3.58, had options been treated as an 
     expense.
       The impact of options can be suprisingly big, however, even 
     if the company hasn't been that generous. At Foster Wheeler 
     Corp., the Clinton, N.J., builder of refineries and power 
     plants, the impact was heightened by a restructuring charge 
     that reduced reported earnings at the same time as its stock 
     took off. The result was that a 1995 grant of only 1.35% of 
     shares outstanding would have slashed the year's earnings by 
     14%, or $4.1 million.
       Tobias Lefkovich, a Smith Barney analyst who follows Foster 
     Wheeler, says nobody noticed. ``Investors are more focused on 
     consistent earnings growth and new orders'' than the option 
     cost, he explains. Nonetheless, Charles Tse, an outside 
     director at Foster Wheeler who serves on the compensation 
     committee, says, ``the whole compensation plan is being 
     reviewed.'' A company spokesman said later that the review 
     wasn't prompted by the stock-option disclosure.
                                                                    ____


                       [From the Washington Post]

         Disney Chief May Reap $771 Million From Stock Options

                            (By Paul Farhi)

       By any measure, Michael Eisner the chief executive of the 
     Walt Disney Co., has been one of America's most successful 
     corporate executives. And by any measure, he has been 
     handsomely compensated for it.
       Eisner, in fact, could be poised to become one of the most 
     richly rewarded employees in the history of American 
     business. Thanks to a new 10-year pay package that includes 
     generous stock options, the top executive of the 
     entertainment conglomerate could reap nearly $771 million 
     over the next decade, according to estimates by the 
     compensation expert who designed Eisner's new contract. The 
     figure doesn't include Eisner's $750,000-per-year salary or 
     bonuses that could add another $15 million annually.
       While Disney argues that Eisner has proved he's worth it, 
     the huge package has raised anew a debate over executive 
     compensation. A group of 22 institutional pension funds that 
     hold Disney stock plans to protest Eisner's contract at 
     Disney's annual meeting in Anaheim, Calif., next week.
       They intend to withhold their votes for the five 
     management-backed nominees to Disney's board--including 
     former Senate majority leader George Mitchell and Roy E. 
     Disney, Walt's nephew--and to vote against a resolution that 
     sets the formula for Eisner's annual bonus.
       The group, which includes the big public-employee pension 
     funds of California, Louisiana and Wisconsin, also is 
     displeased with the severance package awarded Michael Ovitz, 
     the Hollywood talent agent who served as Disney's president 
     for 14 months. Ovitz, who resigned in December, has received 
     $38.9 million in cash from Disney and options on 3 million 
     shares that have a current paper value of $54 million.
       The Washington-based Council of Institutional Investors, 
     which organized the pension fund protest, acknowledges the 
     action is largely symbolic--it is not voting for alternative 
     board candidates. The group's members control about 11.5 
     million Disney shares--a tiny fraction of the 675 million 
     Disney shares in the public's hands; it's not clear whether 
     the action has wide support among other shareholders.
       ``We're merely trying to send a message,'' said Alyssa 
     Machold, deputy director of the council. ``We don't want to 
     start burning Mickey Mouse in effigy. But by not voting, 
     we're calling into question the actions of Disney's board,'' 
     which approved the Eisner and Ovitz packages.
       The organization says Disney's 16-member board includes 10 
     directors whose financial ties to the company could 
     compromise their independence. Mitchell's Washington law 
     firm, for example, provides legal services to Disney.
       Even before his new pay package was disclosed in January, 
     Eisner was often at the center of the executive-pay 
     controversy. In 1992, he made headlines when he exercised 
     options on shares then worth about $202 million.
       According to Disney's records, the 54-year-old executive 
     has reaped $240 million in profits by exercising options and 
     selling stock in his past 12 years as chief executive. As of 
     September, he held stock that would bring an additional $304 
     million of profit if sold.
       His new contract awards him 8 million options. (An option 
     gives its owner the right to buy stock in a company at a 
     particular point in time at a predetermined price; it has 
     value if it permits the buyer to buy stock at a price below 
     the existing market price.)
       Assessing the future value of an option is an inexact 
     science because it requires guessing the future price of a 
     stock. Officially, Disney estimates the value of Eisner's new 
     options at $195.4 million over their 10-year life.
       Raymond Watson, the Disney board member who directed 
     negotiations on the contract with Eisner, says that is a 
     conservative figure, based on the low end of assumptions 
     about Disney's future performance.
       Graef ``Bud'' Crystal, an executive-pay expert whom 
     Disney's board consulted to formulate the contract, said the 
     value of the Eisner deal likely will be much higher. Assuming 
     an 11 percent annual return--Disney's average stock 
     performance for the past 10 years--Crystal calculated Eisner 
     could realize $770.9 million from exercising the options from 
     2003 to 2006.
       Asked about that figure, Watson said, ``I don't dispute it. 
     We looked at it that way and 30 other ways besides.''
       But Watson said Eisner's compensation will be worth it if 
     he can help Disney keep up its historical growth. He noted 
     that options only have value if the company's stock keeps 
     appreciating. Indeed, companies award executive options in 
     order to motivate them to keep share value rising.
       Under Eisner, Disney has been one of Wall Street's stellar 
     performers. Its revenue has grown from $1.5 billion in 1984 
     to $18.7 billion in 1996. And its stock has soared during 
     that period--from $3 per share to $75.37\1/2\ as of Friday, 
     after adjusting for splits.
       Even Crystal, a frequently quoted critic of huge executive 
     pay packages, grudgingly says Disney's board had to offer 
     Eisner his huge new deal. ``The package he got is awesome,'' 
     he said. ``But if Sony had tried to lure him away, they would 
     have offered him Tokyo and thrown in Kyoto as a bonus.''
                                 ______