Sharing the Riches

About 15 years ago, around the time of Sarbanes Oxley but in a separate action the Financial Accounting Standards Board (FASB) decided that stock options should be treated as compensation income and an expense to a company’s operating statement.  Prior to this many stock options were not considered as compensation expense.  They were treated as an equity issue and voted by the Board and reported as an increase in outstanding stock shares.  Since there was no cash outlay for the stock and it had no compensation value on the day it was issued it was not treated as an expense.

I always found it easy to look at a company’s annual report and see how much equity was being designated for the employees.  This percentage of outstanding shares for employees would vary from 5% in older more stable companies to as much as 18% in high growth newer companies.  With today’s GAAP/non-GAAP reporting I find this information much more difficult to find.

Further, prior to this action, there was extensive use of Incentive Stock Options (ISO’s) which were given to employees including executives at a price equal to the market value of the stock at the time of issue.  In other words they had no value on the day of issue and no value going forward unless the price of the stock increased.  Then the employee could reap the benefit of the difference in price between the market price and their issue price (time the number of shares they were given).  The logic was if the company increased its value in the marketplace, employees as well as stock holders would reap financial benefits.  A reasonable incentive it seemed to me.

Alternatively, Restricted Stock Options (RSO) were usually given at a discounted price and the difference between the employee’s price and the market price has always been treated as compensation expense.  15 years ago RSO’s were used minimally and only for executives as part of their compensation incentive.

Today, ISO’s are used rarely.  The number of employees who receive stock options is dramatically less, most notably in public companies.  And executives are the beneficiary of restricted shares often priced to them at no cost.  For shareholders this means fewer stock options are generated for employees which those with significant investments in the market (read “rich people”) will tell you this is good.

Another negative aspect in my opinion is that the incentive for executives has been changed from growing the value of the company to surviving through the vesting period.  It is not unusual for an executive to join a company stay 4 or 5 years and leave with a bundle of money from his/her RSO’s regardless of whether the company grew in value or not.

Maybe I’m old fashioned but I liked the idea of incenting executives and employees to grow the company’s value and for all to share in success.  For employees it didn’t have the financial impact that it had for executives, of course.  But it could be a new car, a new house, a college education paid for.  Today’s professional employee instead can look forward to a 3% raise every year.

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The Shrinking Middle Class

I have a background in Human Resources and I sometimes wonder how much my profession may have contributed to the widening gap between the middle class and the rich.  In the late 1970’s, compensation survey’s became popular.  This was were a third party company would contact all the companies in a particular industry (or geographic area) and collect data about jobs and the pay for jobs.

Companies would compile salary data by job title such as Accountant or Engineer.  This information was then compiled by the third party and sold to companies.  The concept behind it seemed fair.  Everyone would know what the average Accountant or Engineer made and decide if they wanted to position themselves (1) on the market, (2) below the market (and use trainees for example) or (3) above the market.

That followed with companies developing compensation programs that gave higher raises to those who were below the market and smaller raises to those above the market average.  This had the result of forcing people toward the average (because theoretically every year the average moved up some to keep up with the cost of living).

The degree of merit raises were also determined by surveys.  When the first difficult times arrived in the mid 90’s, surveys were already well established and as companies laid people off (especially the older more expensive workers) average salaries, averages raises, etc. went backwards.  Many companies froze wages, skipped merit increases and so forth.

There was a comfort in knowing that most companies were taking similar austerity measures and this knowledge allowed companies to take very conservative positions.  Even after business improved companies continued on a stingy path.  Today the norm is a 3% annual merit increase.  I’m not sure what the cost of living index is but it seems to me like inflation is growing at a faster rate.  If this is true then the middle class is still losing ground.

There are certainly reasons beyond surveys that effect wages.  The overall job market has been negatively effected by jobs moving overseas.  People afraid of layoffs are happy to just have a job as the supply of jobs isn’t keeping pace with the demand.  But it would be naive, I think, to believe that the group mind set that surveys help to create and maintain hasn’t contributed.  It feels a bit like collusion.  Although I realize that if the market had a better balance  – that is, if people were in great demand – then wages would be more inclined to grow.

One final note.  It occurs to me that in the period of the world when the US was becoming increasing more productive as a result of the introduction of technologies in computers and communications, and when significant wealth was being created, the middle class was moving backwards.  There is something wrong with this picture.