The Solid Fringe

The handsomest fringe benefit in U.S. business is the stock option, a corporate incentive that enables a good many executives to make fortunes beyond their salaries. Like a warrant or a "call," the option is a device that enables a man to buy stock at a fixed price long after the shares have risen above that price. Last week's tax bill removes some of the glamour from the stock option, but will not easily stop the growth of an incentive that is now used by two-thirds of the nation's public companies.

Under the new tax rules, an executive who gets an option will have to buy the shares allotted to him sooner and sell them later than in the past. He must now pick up his optioned shares within five years instead of ten and then hold the stock for three years instead of six months in order to have his profits taxed as capital gains at a rate no higher than 25%. Beyond that, he will have to pay 100% of the price that the stock sold for on the day that the option was granted (some companies have awarded options at 85% or 95%). The new rules are retroactive to Jan. 1 but generally do not apply to options granted before then.

Loud Uproar. In the battle over the tax bill, 39 Senators tried in vain to keep stock option profits from being treated as capital gains, pointed out that the U.S. Supreme Court ruled in 1956 that they should be regarded as salary supplements (the Court left it up to Congress to decide whether to tax them as such). Some stockholders have also complained that companies that set aside shares for option dilute their stockholders' equity. In the press and in Congress an uproar followed Chrysler's report in December that 16 of its high executives last year picked up thousands of options at $21 to $31 a share and sold some of them shortly after the minimum six-month holding period at a total pretax profit of $4,200,000. The biggest gainer: President Lynn Townsend, whose profit before capital gains' tax and brokerage fees was $744,000.

Despite the criticism, options are popular with both companies and executives because they attract valued men and are one of the few ways a professional manager can build up an estate in times of high taxes and rising prices. The backers of options--and that includes everyone who gets them--contend that a manager performs better when he has a sizable stake in the company. Small companies that cannot afford high salaries dangle options to attract bright executives or even talented college seniors--and later use options again to keep them from leaving to form their own firms.

While the executive has much to gain from an option, the company has nothing to lose; it simply sets aside a parcel of its unissued shares--usually about 5% of the total stock--for its key men to pick up later. U.S. Steel limits its options to 300 top managers, and many other large companies give options only to vice presidents or chief executives. But General Electric spreads its 4,000,000 optioned shares among 1,555 employees, Westinghouse grants them to plant managers and research assistants, and Hewlett-Packard has even reserved some stock options for top salesmen as well as for scientists who make important discoveries.

Critics Muted. Stock options are not, of course, an unmixed blessing. An executive can take a loss if the price of his stock plunges below the option price --unless he sells out in time. But the rewards can be remarkable. Shares that Xerox optioned in 1955 at $2.47 1/2 are now worth $79 3/8, and options that IBM granted in 1956 at $92 now market for $569. A U.S. Treasury survey of 166 executives in 31 large companies showed that they averaged $82,000 each per year in profits--real or paper--on their options during the 1950s.

After a two-year study of 250 major option plans, Economist John A. Menge of Dartmouth College found that during the 1950s former American Motors Chairman George Romney realized an after-tax profit of $564,000 on sales of his optioned shares, and RCA Chairman David Sarnoff pocketed $1,126,000 from his options. In the 1950s, according to Menge, these were some of the paper profits of executives who held on to most of their options: former Coca-Cola Chairman W. E. Robinson, $1,270,000; Clifford Hood, former president of U.S. Steel, $1,362,000; former General Electric Chairman Ralph Cordiner, $1,710,000; Chairman W. R. Stephens of the Arkansas-Louisiana Gas Co., $2,532,000; Continental Oil Chairman L. F. McCollum, $2,578,800; former Ford Motor Chairman Ernest Breech, $3,185,000.

While the tax bill will lessen such rewards in the future, it will also tend to mute the critics. Because the new law tightens up on options but reduces taxes on salaries, straight salary will also gain in importance as an executive reward. But for men in high brackets, options will remain a solid fringe.

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