Fortunes made by stock options prompt scrutiny HOW SWEET IT IS

July 24, 1994|By Joel Obermayer | Joel Obermayer,Sun Staff Writer

In February, when a top New York analyst was asked about Robert N. Elkins, he answered in three words: "Elkins is king."

What he was referring to was Dr. Elkins' successful reign as founder and chief executive of Integrated Health Services Inc., one of the fastest growing, most profitable companies in Maryland.

As it turns out, though, Dr. Elkins' Midas touch didn't stop there. According to documents filed by 95 public companies in Maryland, Dr. Elkins has also been crowned king of the stock option.

Indeed, thanks to 1.65 million options granted to him last year alone, Dr. Elkins, 51, could reap as much as $74 million over the next decade, according to figures contained in filings with the Securities and Exchange Commission. That does not include the $3.2 million in cash and stock he took home in 1993.

Dr. Elkins' stock option plan not only dwarfs that of the state's runner-up, Bruce L. Crockett of COMSAT Corp., but also exceeds the heads of IBM, Westinghouse and General Motors combined.

While the case of Dr. Elkins is certainly the grandest local example of an extraordinary compensation package, it is but the latest instance of why stock options nationwide have become the target of increased scrutiny.

Proponents of these delayed-pay packages say that they are the best way to link a CEO's pay directly to the future performance of his or her company's stock price. Beyond providing incentives to top executives, pay increases only come if the company, and shareholders, profit as well.

But opponents counter that many of the option packages have grown so out of proportion that the logic behind them has been lost.

"The numbers are obscene. I can't see why someone at that level should have the opportunity to make so much money," said Marvin J. Levine, a professor at the College of Business and Management at the University of Maryland in College Park. "There is no one who is ever going to convince me that the system that [granted Dr. Elkins the options] is a fair system."

Whether fair or not, the idea behind stock options seems simple enough.

A single stock option represents the right to buy one share of stock in the future at a particular price. If the stock rises beyond that price, then the person holding the option can profit. For example, if someone is issued a $10 option when their company's stock is trading at $10-a-share, and the stock rises to $15, they can make a sure $5 profit on paper by exercising the option. Of course, if a stock drops, options would be worthless.

But that's about the only time their value is obvious. In general, it is impossible to predict the value of an option with certainty. But because of SEC regulations, when a company grants options to a top executive, it must now give projections of how much the executive stands to gain. One such projection, assuming the stock will appreciate 10 percent annually, states the gain for Dr. Elkins at $74 million.

Mutual fund managers say a 10 percent stock appreciation is slightly below the average annual return of large stocks over the last seven decades. For midsized growth companies, like Integrated Health, the expected rate of return is higher.

"To me, 10 percent is not much of a hurdle," said Robert J. Sanborn, portfolio manager for one of the country's top performing funds, Chicago-based Oakmark Fund. "You are saying that if you only perform in line with the market, you get a huge payoff."

By the same 10 percent measure, last year's option package for Bruce L. Crockett, CEO of COMSAT Corp., could be worth as much as $16 million, GEICO Corp. co-CEO Louis A. Simpson's, $11 million, and USF&G Corp. CEO Norman P. Blake Jr.'s, $9 million. For comparison, Louis V. Gerstner, CEO of IBM Corp., received one of the largest grants last year among big industrial companies and it could be worth as much as $38 million.

Other valuation methods, however, try to estimate the present-day value of the options, factoring in uncertainty about how the stock will perform. Using a second valuation widely used by compensation experts, Dr. Elkins' options were worth $16 million. Either way, Dr. Elkins is still the top in Maryland.

Accounting standards

Given the size of stock options these days, and their importance as part of compensation packages, the Financial Accounting Standards Board (FASB), the organization that determines accounting standards for company reports, has been considering forcing companies to treat stock options as an expense and deduct them from earnings. The move has sent a shudder through the business community.

Business leaders maintain the regulations would decimate start-up companies that rely on options to pay their best employees.

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