Do Your Employees Understand How Their Stock Options Work?

Here’s something else directors should consider in the debate about stock options and whether to expense them: What is the company doing to make sure employees actually understand their stock options?

Probably not much, says Corey Rosen, executive director of the National Center for Employee Ownership, a research organization in Oakland, California. Most companies, he says, do little more than send out letters, and usually only at the time options are granted. Few hold periodic employee meetings about stock options, and even fewer provide employees with personalized reports or instructions. “Companies are spending millions and billions of dollars on options programs, but only a minuscule fraction of that on making sure the programs are truly effective,” Rosen says. “For the most part, they’re doing a pretty awful job.”

James Hughes, managing director of the compensation consulting firm Pearl Meyer & Partners, says that too often companies assume their employees have an inherent understanding of stock options. “Certainly you have corporate cultures where this is true because everyone is talking about their stock options,” he says. “But my feeling is, more could be done.”

Fidelity Investments says that people in more than 500,000 American households let options expire during the last three years because they didn’t understand how to exercise them. (Another 400,000 allowed their options to expire because the price was underwater.)

It’s not just rank-and-file employees who need more education, says William Briggs, president of Net Worth Strategies, a company that develops financial-planning software to analyze options and offers corporate training programs on the subject. He frequently hears from top-level executives who are baffled about what to do with their options. “They feel comfortable granting stock options and thinking about them from the company’s point of view,” he says. “But when it comes to managing their own from a personal-finance point of view, it’s a different story.”

Fewer than half of the Fidelity study participants who still held unexercised options said they had a plan for when to exercise them. “Employees understand that for the most part, the best thing to do with your 401(k) is leave it alone,” says Briggs. “This isn’t true of stock options. They vest, they expire, they can become less valuable over time.”

To help employees understand stock options, companies need to realize that people learn in different ways, says Rosen. Some respond well to face-to-face explanations, while others do better with written communications or interactive tools. “Using multiple techniques is essential,” Rosen says. And don’t stop at one session: “It’s better to do a so-so communication every few months than a whiz-bang communication every two years.”

One company that does a good job of talking to its employees about stock options, according to Rosen, is Cisco Systems. “They use multiple communications,” he says, “but at the core is an elaborate website where employees can determine the value of their options and analyze different alternatives for exercising them.” In addition, Cisco provides a number of training programs that help employees learn how the company operates and specifically how their work affects its performanceu00e2u20ac”and, in turn, their own fortunes.

Of course, it helps if a company’s stock is doing well. Cisco’s shares rose 85% in 2003. By contrast, not even the finest learning program could have done much for anyone holding options at Qwest Communications. Its shares fell 14% during the year.