Silicon Insider: A Defense of Stock Options
Nov. 26, 2002 -- When it comes to money, always bet that people will choose short-term cash over long-term financial gain … and that Washington will always back them, even if it wrecks the economy.
A case in point is stock options. For the last 40 years, stock options have been the most egalitarian force in the U.S. economy. Options put corporate ownership in the hands of people who never held stock before. In uncounted cases, options have given ordinary folks an opportunity they never dreamed of: to become rich.
And thousands did. When Apple Computer went public in the early '80s, it created more than 100 millionaires, many of them secretaries and clerks. In the years that followed, Cisco, Siebel, eBay, Microsoft, Oracle and many other high-flying companies did the same for thousands more.
Stock options, in fact, founded Silicon Valley. It was frustration over Fairchild Camera's unwillingness to share its wealth in the form of stock that led the employees of subsidiary Fairchild Semiconductor to depart en masse and start Intel, AMD, National Semiconductor and all of the other pioneering companies of Silicon Valley.
More than that, stock options have always been the heart of high tech entrepreneurship. Why else would you leave a comfortable, high-paying job at an established firm to take on the long hours, hard work and high risk of a tech start-up if not for the stock options and the chance to become a tycoon on the back end?
Without stock options, there would be no semiconductor chips, no personal computers, no video games and no Internet. Throw in software too, because Gates, Ellison and the others never could have started their companies — and retained talent — without the bait of founders stock.
Stock Option Backlash
Of course, like many other things, stock option frenzy reached a kind of insane apogee during the dot.com bubble.
Suddenly, every 20-year-old dot-commie was sitting on a pile of options, a self-proclaimed paper millionaire. That infuriated people who had worked hard for years in normal jobs. Many found themselves deeply resentful at the arrogance of these children and the ease with which they'd apparently grown rich.
Worse, many of the people who were granted options made the suicidal mistake of believing either that their unvested shares were in fact real money, or assumed that the bubble stock prices would last forever. An especially tragic minority treated options as if they were pensions, a sinecure for old age.
Then the bubble popped. The economy slumped and stock prices collapsed. Millions of option shares went underwater — that is, they were worth less than what it would cost to exercise them.
On top of that, millions of shares were in the hands of people who worked for companies, like Enron, that were little more than criminal enterprises. In the minds of these shareholders — and government officials — these options were part of the overall scam. The cry came to harness stock options, to somehow reign in this maverick, underscrutinized financial tool.
A Short-Sighted Choice
Outside of Silicon Valley, few people know that the Feds tried to domesticate employee stock options once before. Nearly 20 years ago, under orders by the SEC, the Financial Accounting Standards Board set out to turn stock options into a line item expense on the corporate sheet.
The result was public protests and rallies in Silicon Valley and in other tech enclaves around the country. Not only were companies against expensing options, so were the employees themselves. In the end, the American Electronics Association, working with Sen. Joseph Lieberman, crushed the FASB plan.
Silicon Valley assumed the fight was over. But FASB and the SEC never forgot. And last year, with the stock market down and corporate scandal in the air, they struck again.
Now they had a new ally: high-tech workers. As long as the going had been good, tech's rank and file had been the biggest defenders of options. Now that those options were (for the moment at least) worthless, they were willing to ransom their future for some quick cash now.
Some of this was understandable. When you can't make your mortgage, you'll happily trade your chance at riches ten years from now for a few bucks today.
But even as you rationalize that decision, the larger truth is that it is a foolishly short-sighted choice. Without options, high tech becomes as hierarchical and undemocratic as those old smokestack industries it was designed never to become. The digital world becomes forever stratified, with senior executives getting their high salaries AND stock, and everybody else drawing wages.
But that's not the worst of it. The real disaster in ending easy stock options is that it will quickly kill entrepreneurial start-ups, the dominant force for economic health and job creation in this country. Without options, how can an inevitably cash-poor new company ever recruit the kind of talent it needs to succeed?
The Democratic Option
Is anyone is Washington thinking about any of this? They sure are on Silicon Valley.
A few nights ago, uber-venture capitalist John Doerr got up at a local gathering and angrily denounced the FASB plan as a threat to the very future of electronics. He won't be alone: tech executives were as depressed and intimidated as anybody by the downturn and scandals of the last couple years.
But now, as the economy begins to stumble back, the execs are going to come out fighting. As I write this, Cisco just announced that, had it expensed stock options, its most recent quarterly profits would have been cut by 60 percent.
Meanwhile, the Feds are couching their case as one of fairness. After all, goes the argument, why should tech companies be able to keep options off the books, while old line companies don't get the same break? Um … maybe because 1) Giving out stock options is morally good; 2) It's fairer, more democratic, and better for the economic health of this country; and 3) Because no one really knows how to expense high tech stock options.
That last is one thing the Feds don't like to talk about. Just like last time, FASB has hauled out an arcane statistical technique called Black-Scholes that is supposed to provide an accurate estimate of what a given company's options will be worth. The nasty little secret is that Black-Scholes doesn't really work in a dynamic entrepreneurial environment in which a handful of companies become superstars and the most of the rest die without ever vesting their options. It will prove to be at least as 'unfair' as the current systm; but — and this is why the accountants like it — it will at least put some kind of number on the balance sheet.
But even if Black-Scholes did work, should we use it? The real problem with stock options is not that they are unfair, but that not enough companies use them. The real problem with stock option awardees is not that they have been cheated, but that they deluded themselves.
You don't often hear me lauding the work of high tech executives in this column. But this time, folks like John Doerr are being heroic. Guys like him will always get their stock options, so they have no personal stake in this fight. Nevertheless, they are still fighting for the rank and file of electronics — even though those same workers are against them — and for the future of the electronics revolution.
A couple years from now, when tech is booming, stock prices are high, and we are all scrambling for every option we can get our hands on, or starting our own dream company, we'll thank those people who fought both Washington and our own short-sightedness.
Michael S. Malone, once called “the Boswell of Silicon Valley,” most recently was editor-at-large of Forbes ASAP magazine. His work as the nation’s first daily high-tech reporter at the San Jose Mercury-News sparked the writing of his critically acclaimed The Big Score: The Billion Dollar Story of Silicon Valley, which went on to become a public TV series. He has written several other highly praised business books and a novel about Silicon Valley, where he was raised. For more, go to Forbes.com.