ISOs

There was a monkey pile in one of the financial message boards I read where people were rushing to denounce the incentive stock options (ISOs) awarded to executives. The main gripe was that the exercised options were draining money out of the company that "should" have been going to ordinary shareholders, or at least remaining in shareholder equity. One post read, in part:

I for one am against any "incentive stock options" for executive officers. Just like the other workers they do not need any incentives to perform what they were hired to do in the first place.

This is just the kind of straw man I love to pummel, but let me approach from my own, non-executive perspective. I am a non-supervisory technical professional with decent qualifications. There is a job description for my position. Nowhere on that job description do I see that I have to respond to a phone call at 2 a.m. to drive an hour round trip to handhold a client as he gets a unit back online. That might be in the on-duty serviceman's description, maybe the project manager's job description, but not mine. Yet I find myself doing such things from time to time. I think it is inarguable that it helps the company, its image, its efficiency, and ultimately its revenue.

Now the primary reason I will do that is professional pride, not ISOs, since I have done that sort of thing previously in the absence of ISO compensation. But it wears thin over time, particularly when the company's hiring is lagging its business upswing. Over time, you start to notice that the manufacturing and service guys are earning overtime premiums and sometimes big holiday windfalls, whereas your own extra hours and night calls haven't earned you one extra dime. You are salaried, after all. Six to nine months of that and you're checking the job market, shopping around for the higher salary -- since without the time-vested incentives there's little reason to put up with increasing work for a below-industry-average paycheck.

Now you can see that I'm already alluding to another reason for ISOs: they potentially allow a cash-strapped company to retain people with the promise of future compensation. The company gets to restrain the cash-burn going into professional salaries at the expense of future options costs. The future options only cost the company if the options are exercised in-the-money, which is only the case if the stock went up, which should only be the case if the company is meeting with success. Really seems like a win all around.

When you consider that it can literally take years for even a seasoned technical professional to become fully productive within a new company environment (new tools, new procedures, different product line), if ISOs really do diminish turnover among those workers then they're probably a bargain. Getting back to the original comment that fueled this rant, I think the commenter is just totally missing the point. ISOs are not for getting people to "do their job." I believe they're for motivating people to go above and beyond, particularly where straight salary awards are limited, and are an added retention mechanism for the more critical individuals. And while the original post admittedly addressed "executives" specifically, I have a hard time believing that there are not executives who are as critically important as certain other workers. One can quibble with the magnitude of the ISOs awarded -- did the CFO really merit 25,000 option shares when he was promoted -- but that's not what the post talked about. And since the posters did not sanction ISOs for anyone at all, how could it not have been a condemnation of the ISOs themselves?

The poster can rail on and on with, "Here's your salary, do your job!" But how does he respond when half of engineering gets fed up and leaves for Johnson Controls, say? The stick only goes so far when the economy is booming, and it's even less effective against highly-credentialed workers, even in the lean years. Sometimes there's no substitute for the carrot.