Lee's next stop was 3-Com. He had received a near-identical offer from Cisco Systems, but then he sat down with the financial histories of the two companies side by side. One thing stood out: Cisco's stock had split numerous times; 3-Com's had never done so. It was overdue. Lee believed that having more shares would give him a psychological boost and could offer a bigger payout down the road. He arrived for his first day of work at 3-Com and opened up his very first E-mail message--which announced a stock split.
Lee had learned at Synoptics how volatile technology stocks could be. He resolved to diversify. "I decided to exercise my options every year and invest in other people's companies." Now Lee--with a fistful of options--has joined GRIC Communications, a start-up that's developing a global communications technology using the Internet. He thinks it's a good time for a change, because the stock market has been so hot of late and he believes it's due for a breather. Also, he can afford the change to a start-up. "I made enough money in the last two companies that I'm willing to take more of a risk," he says. He adds that as the head of a business unit at GRIC Communications, he must recruit new hires. "I have people asking about stock options before salary now. It's the number one thing they want," he says.
Frank Lee as the option-savvy employee may be a portent of things to come, but for now, what's more typical is the unsophisticated worker who knows little about options.
"They didn't have a clue." That's how Doug Mellinger, the CEO of PRT Group Inc., describes his employees' understanding of options in the then-private company. (See " The Antihero's Guide to the New Economy," January.) Their cluelessness hit Mellinger when he and an employee of the New York City-based financial-services software developer were traveling by plane. During their conversation, the employee told Mellinger that options in the company "weren't worth very much" because their purchase ("strike") price was so high, $56 a share. The employee could find countless stocks at lower prices and hence could buy many more shares in those companies. Mellinger was stunned. He tried to explain the difference between price and value and that PRT had only 1.2 million shares outstanding. "I realized this was a very pervasive problem," Mellinger recalls. PRT was a company with paper millionaires who hadn't even bothered to read the documents outlining the option program. "We found that we had very senior executives who had no idea how the program worked," he says. Before taking the company public last year, Mellinger instituted an education program to explain to employees how the stock was valued and how options work.
Mellinger's experience corroborates the work of Mark Lang and Steven Huddart, professors of accounting at the University of North Carolina and Duke University, respectively. They have studied option-related transactions in a number of companies to gauge how employees perceive options. Lang and Huddart found that most workers exercise their options quickly and then sell their shares prematurely, which on its face contradicts the notion of granting options as long-term incentives. "They are willing to give up a lot of the option's theoretical value in exchange for getting rid of the risk," says Lang. "Market volatility spooks most people. A lot of them are reading the Wall Street Journal daily. They see a two-point drop in their stock, which translates into a $40,000 loss of wealth. It doesn't take much of that before they get out."
Lang and Huddart often speak to executive groups about options and find their members have only a vague understanding. "Very little is known about how options really work," says Lang. "Managers are surprised when they see an employee bail out after 5 years on a 10-year option. They don't know that this is common." Lang says that options can represent a substantial future liability to a company, "yet they are not highly valued by the employees." Maybe with good reason. After all, small companies are volatile; they're adept at destroying shareholder value.
That happened at Molten Metal Technology Inc., a Waltham, Mass., developer of technology to treat toxic waste, which declared bankruptcy in December 1997. Two years earlier the stock had traded as high as $40 a share. Liz Brodbine Ghoneim, formerly Molten Metal's director of contractors compliance and business administration, came to the company in November 1993, nine months after it had gone public. "I know a lot of people who started with the company before it was public and were able to cash out their options," she says. Her options had been granted at $24.75, but before they vested, the stock had sunk below that level, making her options worthless.
