In the first half of 2005, at least 34 companies have awarded to executives a total of 148 stock option or restricted stock grants whose strike price exceeds the price of their company’s stock at the time they were granted. That’s according to Tim Ranzetta, president and COO of compensation research firm Equilar, Inc., which tracks such “premium-priced” option grants.

Several large enterprises granted such premium-priced options, including IBM, Sprint and Computer Associates.

According to Equilar, the average premium-priced option was granted at a price nearly 18 percent higher than the stock price on the grant date, although most of the grants were issued at a premium closer to 10 percent—the median premium was 10.7 percent. In fact, Equilar notes that the “mode”—a statistical term referring to the value that appears the most frequently—was indeed 10 percent.

Some companies, however, granted options at a much higher premium. Computer Associates, for example, granted options to 10 executives at a stock price of $32.80, which was 20 percent higher than the $27.23 stock price on the grant date. “This was part of a decision made to overhaul our incentive plan,” says a spokesperson for the software giant. “It better serves the company’s strategic objectives.”

$1.8 billion Polaris Industries, which makes all terrain vehicles and snowmobiles, granted stock options to its chief executive officer as well as president and COO at a 15 percent premium over the stock price on the date of grant of $65.40. A company spokesperson elaborated that the company began awarding premium-priced options to top executives seven years ago. “It’s a negotiated thing,” he explained. “It was an incentive to improve the performance of the company comes through the stock price eventually.”

Sprint Corp. also recently awarded to its senior officers—about 30 executives—stock options whose strike price was 10 percent premium higher than the company’s stock price at the time of grant. They then vest in equal amounts over four years. “This is the first year we are doing it,” says Claudia S. Toussaint, vice president of corporate governance and ethics, and corporate secretary for the telecom giant.

Not Catching On

Friske

However, most experts say that—while a growing number of companies seem to be mulling premium-priced options and an increasing number seems to be embracing this form of compensation—they don’t place much significance on these developments. “I wouldn’t call it a trend at this point,” acknowledges Doug Friske, managing principal at Towers Perrin. “It’s one of several different designs being used for long-term incentives in general.”

Koors

“I am just noticing it anecdotally,” concurs Jan Koors, managing director of compensation specialist Pearl Meyer. In fact, Meyers and others expect it is unlikely that premium-priced options catch on as a ubiquitous form of compensation because of management attitudes and political hurdles. “While shareholders like them, executives don’t like them,” Koors says.

That’s despite the fact that the compensation form might become more appealing as companies begin to expense the value of options, as required by the new Financial Accounting Standards Board rules. “Premium-priced options will clearly decrease the Black-Scholes or binomial value of the grant,” explains Koors. “And, depending upon the premium, they can lower the value substantially.”

Nevertheless, most recipients do not like premium-priced options because the grants are relatively worthless until the company’s stock price increases beyond the premium strike price codified in the grant. Executives argue that myriad factors impact a company’s stock price—from the cost of raw materials to the impact of hurricanes—so tying compensation to such a metric is unreasonable.

Conversely, performance-based restricted stock is typically awarded to recipients once they meet the required hurdles. Often, those hurdles are unpublished or vague, like a grant to the CEO of Activision Publishing that was dependent on the executive achieving “certain performance objectives to be determined by Activision Publishing.”

Some companies have attempted to overcome this by granting more options as part of the premium-priced award, but it’s still been difficult to convince executives that the grants make sense. “Executives for some reason don’t focus on the fact that they received additional stock options to deliver the same economic value that the company’s independent compensation committee determined appropriate,” admits Sprint’s Toussaint. “I am not convinced that we have successfully overcome that communication challenge.”

She also is not convinced that the governance community and shareholders necessarily have embraced premium-price options as key mechanisms to appropriately reward executives and align executives’ and shareholders’ interests. The focus seems to be much more on performance-based features of full value equity. As a result, she says she characterizes the experience with premium priced options as “mixed.”

Getting It Together

So what convinced Sprint to issue premium-priced options?

According to Toussaint, the company’s compensation committee works on a regular basis with consultants—currently Watson Wyatt and Deloitte Consulting—to review trends in compensation and conduct market analyses. The committee urged the consultants to look at performance-based programs, and to analyze what other large companies were doing, with the goal of offering a leading compensation program to its executives.

As a result of this effort, says Toussaint, the Sprint compensation committee identified that there were clearly many choices such as premium-priced options, which the consultants described as “evolving.” So beginning 2005, certain groups of Sprint executives are receiving premium-priced options coupled with performance-based restricted stock units. “To be even granted, the company must achieve certain performance standards,” Toussaint stresses. If the company exceeds the goals, then additional restricted stock units are granted.

Toussaint

The next challenge for the company is getting its compensation practices in line with Nextel’s. The two companies announced a merger on Dec. 15, 2004, and shareholders approved the deal last week. “I’m not sure where it will end up,” says Toussaint, “but there is a strong commitment at both companies—at the board and executive level—to be a leader in best corporate governance practices following the closing of our proposed merger.”

However, not all companies are granting premium-priced options to be “leaders” in corporate governance.

According to Equilar, $1.1 billion Federal Signal recently granted options to its president and CEO at an exercise price of $16.01, which was 12 percent higher than the $14.26 stock price on the grant date.

According to a company spokesperson, the grant marks the first time that Federal Signal has awarded premium-priced options. However, a Federal Signal spokesperson acknowledges that the company wasn’t exactly implementing a best practice. “It was more of an administrative issue, not the start of a new trend,” she told Compliance Week. The spokesperson stressed that the company has been giving options at the money and “will continue to do that as we go forward.”

When pressed as to what kind of administrative issue it was, the spokesperson conceded, “If we had all of the papers together, the options would have been priced at the money … it was that sort of issue.”