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The Herald-Sun - Durham, North Carolina


March 28, 1999, Sunday

KR-ACC-NO: DR-STOCK

LENGTH: 812 words

HEADLINE: Employees Often Not Advised to Diversify Beyond Company Stock Options

BYLINE: By Karine Michael

BODY: Stock options used to be granted only to upper-echelon executives, but today most public companies - especially fast-growing Fortune 1,000 corporations - grant stock options to employees in many levels of management.

In the last five years, stock options have become one of the most popular ways to compensate current employees and lure new hires. Stock options give employees the advantage of buying shares of stock at below-market prices, so they can buy more shares and benefit from the growth of the company. For example, if a stock is trading on the Nasdaq at $ 55, the company may issue a 4-year option to buy the stock at $ 20.

More than 11 million employees working for public companies have exercised their stock options under 10,000 different employer stock plans, said Michael Beriss, senior financial planner at American Express Financial Planners in Bethesda, Md.

In fact, almost three-quarters of all companies with sales of $ 50 million or less are offering stock options to 100 percent of their employees, according to the International Association for Financial Planning in New York City.

"In dollar terms, stock options can be enormous," Beriss said, citing IBM's stock option plan that tips the scale at $ 7 billion. "It keeps growing every year because it's much more broader and inclusive to all employees."

An accounting rule that allows companies to give stock options without incurring processing charges has helped spur more offerings to employees. "We grant stock options as soon as a new hire walks through the door," says Zena Anderson, a human resources representative at Cisco Systems Inc. in Research Triangle Park. "Each year, the employee is granted stock options based on their performance."

At Cisco, high-performing employees are rewarded with stock options as well as annual bonuses. "It's a way to gauge someone's performance," Anderson said. "Each manager decides how many stock options an employee has earned."

While these plans can be used to attract talent and retain valuable employees, a national survey conducted by the International Association for Financial Planning found that 90 percent or more of employees' investable assets are bound in their company's stock.

"In the financial planning industry we are finding that employees are putting half of their net worth into the plan," Beriss said. "Often this can be dangerous if they're looking at using stock options for retirement or other long-range investment goals."

These investments carry some risk, especially if the company's stock value suddenly drops. The growth of those investments hinges on the continual growth of the company and its financial success. To keep from having assets overweighted in a one-stock portfolio, Beriss suggests contributing to other funds and retirement accounts.

"You can continue to invest in your company, just make sure you are contributing to other supplemental investments, such as [Individual Retirement Accounts] and mutual funds," he said. Many times employee programs don't do enough to promote other forms of investments.

Anderson said that's not the case at Cisco Systems, where employees can sign up regularly for investment courses on how to plan for retirement and their children's college expenses.

The advantage of receiving a stock option below market rate often sparks an early exercise of stock long before the option expires, according to Steve Huddart, an associate professor of accounting at Fuqua School of Business at Duke University. In his 1998 study, Psychological factors and stock option exercise, Huddart found that people chose to exercise their options even if the pricing wasn't too advantageous and many cashed out of plans too early. Because stock options have no inherent value (they expire worthless unless exercised), Beriss said it is often difficult to determine when to vest in an option and when to pass it up. "It's better to go to a financial planner and talk about the tax implications and overall value long before the option expires," he said.

Employees should always know how much stock options they have and what is the value of the stock.

Huddart said that employees should know how their stock options work, when the options expire and what limitations or restrictions employees are subject to under the plan. Ask the stock administrator for a copy of the employee stock-option documents, Huddart said.

By periodically looking over stock option grant letters, employees can make an annual schedule of the amount that was vested and when. This will make things easier come tax time, Beriss said.

It's also important for employees to know what the grant prices were and what their tax fees are if they decide to take a distribution on the stock.

Questions that employees with stock options should ask themselves.

- Do employees own too much of their company's stock? More than 50 percent of an employee's investment portfolio should not consist of his or her company's stock. Most professional financial advisers agree that diversification is the most important financial planning step for those owning employer stock.

- Is the company's stock a good investment?

Most professional financial advisers believe employer stock ownership can have a positive influence on an investor's portfolio, but how much depends on the employee's personal financial goals and the company's future performance.

- Are employees missing out on special tax opportunities

Employees should sit down with a financial planner to review their company's stock option plan and map out a strategy. There are a host of tax issues to consider, such as whether to sell off shares of stock, what will be the source of funds to pay taxes on that stock distribution, whether to pay or defer taxes and whether employees qualify for the Alternative Minimum Tax, a flat tax for high-income individuals.

- How does owning stock affect estate planning? Many stock-based plans do not transfer under the terms of a will. Some employers offer lifetime transfer of stock options. More and more companies are amending their stock-option plans to permit certain employees to transfer options to their children or to trusts or partnerships for their children.

- Should employees be concerned about insider trading?

People owning company stock should be aware of insider trading issues. A trade is considered illegal when someone buys or sells company securities while having financial information not available to the public.

Source: International Association for Financial Planning

GRAPHIC: Photo/Computer art: BRIAN CLEMENT & JOE WEISS, Carton of eggs labeled "employer stock, grade A," and eggs have $ symbols on them.

Copyright 1999 Knight Ridder/Tribune Business News Copyright 1999 The Herald-Sun


Steven Huddart
Smeal College of Business, Penn State University, University Park, PA 16802-3603 USA
(814) 863-0048
huddart@psu.edu
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