Drug distributor Omicare (NYSE:OCR), an Inside Value pick, disclosed the restricted stock and stock option components of its 2005 executive compensation plan in SEC filings yesterday. Under the plan, top executives acquired 384,000 restricted shares (shares that can't be sold immediately) and 809,000 options.
Omnicare's compensation strategy may be ahead of its time. With the push to expense stock options, companies may choose to shift, as Microsoft (NASDAQ:MSFT) has, to compensation plans that focus on restricted stock awards rather than options.
Stock compensation has always been expensed. However, the new rules dictated by the Financial Accounting Standards Board (FASB) make accounting for option grants closer to the rules that apply to restricted stock grants. As a result, companies that historically chose to award options rather than restricted shares -- because options would reduce reported income, while restricted shares would not -- may well be reconsidering their policies.
From an investor's perspective, the ideal is for executives to step up and buy shares, rather getting them as freebies from the company. After all, if I'm risking my money by purchasing shares, I'd like to have the people who run the company take the same risk. Of course, this rarely happens -- and, since executives don't buy the stock like we do, it boils down to the question of whether the company gives its executives actual shares or stock options.
In that case, given a choice between restricted stock compensation and option compensation of equal value, I'd prefer to see stock awards. Options have a built-in time limit; if they aren't exercised to buy shares within a certain period of time, they expire. Consequently, management may be concerned about short-term results in an effort to maximize the value from stock options before they expire. But, as a part owner of a company, I care about long-term performance. I don't want executives making decisions that maximize short-term results, potentially at the expense of the long term. It's better for investors if management thinks like shareholders, rather than option-holders.
That said, when comparing restricted stock to options, it is important to compare the value of the awards. Options on shares are much less valuable than the shares themselves. So, as a potential investor, I would expect the number of shares of a restricted stock award to be significantly less than the number of shares underlying an "equivalent" options award.
In Omnicare's case, the awards seem reasonable. The majority of the restricted stock awards become unrestricted at a rate of 10% per year for 10 years. This slow rate should encourage a long-term outlook, exactly what this sort of compensation is supposed to achieve. The size of the grants appears to be similar to 2004, when there was 1.3% dilution due to options, and 0.6% dilution due to restricted shares. These levels are higher than I would like, but are still acceptable.
For more Foolish ideas, check out:
- Thoughts on Omnicare's recent quarter
- The bizarre options arguments by some politicians
- Stock options' perverse incentives
Fool contributor Richard Gibbons, a member of the Inside Value newsletter team, does not own shares in any company mentioned in this article, nor does he distribute drugs.
