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Restricted Stock Is Better Than Stock Options

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Many companies are concerned by the Financial Accounting Standards Board (FASB) recommendation that stock options be shown on the company's expense sheet. Especially high-tech and start-up companies are concerned because they fear losing one of their great motivating tools. They needn't worry. There is already a better compensation choice, restricted stock options.

Motivation Through Restricted Stock

Issuing restricted stock is a better motivating tool than granting stock options for two reasons. First, many employees don't understand stock options. They don't know that they have to take action to realize any gain. It is far easier for them to understand a vesting period on restricted stock. Second, restricted stock can't become worthless like stock options. Even if the stock price falls, restricted stock retains some intrinsic value.

A stock option grant with a strike price of $10 has no value when the stock trades at $8. Restricted stock awarded when trading at $10 is still worth $8. A stock option has lost 100% of its value. The restricted stock has only lost 20%.

Employee Ownership Through Restricted Stock

One of the advantages restricted stock has from a management perspective is it is better at motivating employee to think and act like owners. When a restricted stock award vests, the employee who received the restricted stock becomes an owner of the company. He or she has to take no further action to make it happen. The employee is now part owner and can vote at the annual meeting.

Actual ownership of part of the company is a powerful motivating tool in trying to get employees to own the company's objectives. This makes them more focused on meeting goals.

Stock options, on the other hand, do little to instill a sense of ownership. They are viewed by most as a high risk gamble that has a potentially great reward. An individual may very well invest a couple of years helping a company grow and prosper when compensated for that time by stock options. However, their loyalty is to raising the stock price so the can cash out and make a bundle. They have no loyalty to the company and its goals. Often, they will choose actions which raise stock price in the short term, thus increasing their potential gain, rather than taking a longer-term view that will help the company.

Restricted Stock Supporters

The LA Times reports that Microsoft plans to replace stock options with restricted stock grants. Amazon.co.uk notes that all their employees are allocated a number of Amazon.com restricted stock units when they join. The Altria Group, Inc., points out in their annual report that "in 2003, we made equity awards in shares of restricted stock rather than fixed-price stock options". Dell Computer Corp., Cendant Corp., and DaimlerChrysler AG are also reported to be moving toward restricted stock in lieu of stock options.

Restricted Stock FAQ

If you have questions about restricted stock awards as a motivating form of compensation, see the Restricted Stock FAQ. There is a comparable FAQ about stock options here.

Manage This Issue

Restricted stock awards are a better tool for motivating employees than stock options. Restricted stock awards are better than stock options for motivating employees to think and act like owners. Restricted stock awards are better treated on the financial statements than stock options. That makes restricted stock awards better for the employees, management, the investors, and the regulators. There is no reason to not make that choice.

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