When Tyco International’s proxy was filed last week, most observers focused on the hefty 2004 pay package for chairman and chief executive officer Edward Breen, which worked out to $10.7 million.

However, what stood out even more to some were the 600,000 stock options that Breen received, because all of them were premium-priced options.

Under the plan, one-third of the 10-year options are exercisable at $33 a share, another third at $36 and the rest at $40. The grant price, however, is just $27.795. This means the premium is as much as 43 percent.

Breen is the only one of the five Tyco executives whose compensation is published in the proxy to receive premium-price options. The rest received options that were granted at an exercise price equal to the fair market value of Tyco common shares on the grant date.

12 Of 2,000

“They [premium-priced options] are not common,” confirms Steve Van Putten, compensation practice leader for Watson Wyatt. “They are still very rare,” agrees Towers Perrin Managing Principal Doug Friske.

In fact, the Investor Responsibility Research Center says just a dozen companies out of approximately 2,000 in its core universe that have granted premium-priced options.

One major company that received a fair amount of attention when it moved to awarding premium-priced options was IBM.

Last February, Big Blue said it will only make outright, annual grants of stock options to senior executives with a strike price that is 10 percent higher than the market price on the day the options are issued. “As a result, IBM executives will not realize any value from these so-called ‘out of the money’ options until IBM's share price increases more than 10 percent from the date the options are issued and the options are vested,” the company said at the time.

“This looks attractive from a shareholder communications standpoint,” says Van Putten.

In addition, IBM said the only way senior executives will be able to acquire stock options at market prices is if they first purchase IBM shares of a corresponding value at the market price with their own money. For example, in order for a senior executive to acquire market-priced stock options with a target value of $18,000, the executive must first invest a portion of his or her annual cash bonus to purchase $9,000 of IBM stock. The executive then must retain ownership of all of the purchased shares for at least three years in order not to forfeit the entire option grant.

The company said this policy “further encourages executive ownership of the company.”

Premium Examples

A number of other companies have some form of premium-priced options as well. Here’s a sampling, according to Tim Ranzetta of compensation research firm Equilar:

In late December, Ventana Medical Systems provided five executives with five tranches of premium-priced options with varying exercise prices, which ranged from a 5 percent to 27 percent premium to their stock price on the date of the grant.

Two-thirds of the stock options that MDC Holdings granted to its chairman/CEO and president/COO last Nov. 22, 2004, were granted at an exercise price 10 percent to 15 percent above the closing stock price on the date of the grant.

Also in November, Stamps.com options granted to seven of its executives all were priced at nearly 22 percent above their closing stock price of $14.36 on that date. The options vest immediately.

Zix Corp granted three of its executives with options that all had an exercise price 24.7 percent above their closing stock price on Nov. 17, 2004. These options “vest quarterly and pro-rata over three years from grant date and subject to accelerated vesting upon the occurrence of specified events.”

The IRRC also recently noted that Acuity Brands recently granted its newly designated CEO Vernon Nagel two options, each covering 150,000 shares, effective Jan. 20, 2004. One of the two grants was a premium-priced option, which does not begin to build value until the company’s stock price rises to more than 20 percent above its price on the date of grant.

“Premium priced option plans seem to be a good way to ensure that a company’s performance [as measured by its stock price] exceeds a certain hurdle before an option holder shares in the upside,” Equilar’s Ranzetta notes. “This premium aspect helps to address concerns about the ‘rising tide’ phenomenon when option holders benefit from an overall increase in stock prices.”

Benefits experts, however, don’t expect premium-priced options to become a growing, popular trend. For one thing, there is no tangible benefit to employees. In addition, premium-priced options don’t mitigate the expense under FASB’s new rule for options and other stock-based compensation. “It’s a non-reversible expense, so it loses some attractiveness,” adds Van Putten. “I don’t see it gaining traction; not with expensing around the corner.”