Announcement of Option Expensing Has No Impact on Share Price, Towers Perrin Study Finds; Study Examines Share Performance of Over 100 Companies Expensing Options Since July.

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NEW YORK--(BUSINESS WIRE)--Nov. 21, 2002

How did investors respond to the announcements made since July by more than 100 companies intending to include option expense on their income statements?

The answer, according to a Towers Perrin event study that tracked share price during the 60 trading days before and 60 trading days after company declarations, is that share price performance during the period was the same, on average, as the S&P 500.

The study provides substantial support for the view that accounting portrayal of incentives does not influence stock prices. "Investors do, in fact, take into account the economic cost of options, even though such an expense may not be previously reflected on the income statement because of favorable accounting treatment," said Richard N. Ericson, a Towers Perrin principal who co-authored the study with Michael J. Grund, a Towers Perrin executive compensation consultant.

"Financial performance does affect stock prices, and well-designed incentives can improve performance," Ericson added. "Companies should pursue business efficacy -- the power to produce results -- rather than bookkeeping expediency when setting up incentive plans for management."

Study Methodology

The study examined stock price reactions of 103 companies that announced in July and August that they plan to adopt FAS 123, expensing options in the income statement. Stock prices for announcing companies were standardized to a uniform $10 per share closing price on the day before announcement and adjusted to reflect general market movement (see accompanying chart).

Once adjusted for general market movement, the average stock price of announcing companies did not show any significant change during the 120 trading days surrounding the declaration. Since stock prices did not change in response, the study shows that the economic costs of using options were previously known regardless of whether book cost would be appearing among company P&L expenses for the first time.

"Markets are very good at reflecting available information in security prices and were already awash in information about option grants and their economic costs," said Scott Olsen, co-leader of Towers Perrin's Executive Compensation consulting practice. "The study notes that in similar past situations, stock markets have ignored accounting and have paid attention to economics -- for example, when examining company accounting choices in areas like inventory, depreciation or business combinations."

Based upon 2001 footnote data, option expenses for the announcing companies reduced EPS by an average of 10%. The study further found that the relative size of the prospective EPS impact of the option expense did not affect share price reactions. At the median, revenue for the most recent year for companies profiled in the study was $6.1 billion, and current market capitalization is approximately $5.9 billion. The companies analyzed came from a very diverse group of industries, including energy, financial services, aviation, manufacturing, pharmaceuticals, technology and utilities.

Stock options don't come with instructions on how to create value, and option-heavy pay structures have poor "line of sight," according to Ericson, who believes these issues and a range of other problems with incentive structure can be addressed through a threefold approach:

-- making better use of incentive plans based upon actual operating results, so outcomes are more closely linked with management's actions; as part of this, companies should improve upon the target-setting and measurement methods normally used

-- making more prominent use of value-based methods -- that is, incentive plans that emphasize long-run operating results, capital usage and business risk, each in proportion to its impact on value creation

-- placing greater emphasis on business units within the company, an approach particularly applicable to companies with fairly separate groups, divisions or profit centers.

Go Beyond Competitive Norms

"As part of a redesign process, companies should break the habit of mimicking competitive norms," said Gary Locke, a Towers Perrin principal and co-leader of the firm's Executive Compensation practice. "Instead, they should use the competitive market simply as a source of information on best practices, tailoring those for 'best fit' in view of their own specific challenges and circumstances."

About Towers Perrin

Towers Perrin is one of the world's largest management and human resource consulting firms. It helps organizations manage their investment in people to achieve measurable performance improvements, focusing on human resource strategy and service delivery, benefit and compensation design and implementation, employee and organizational communication, HR technology and outsourced HR administration. Towers Perrin is part of a broader family of businesses that also includes Tillinghast, a management consultancy for financial services companies worldwide, and Towers Perrin Reinsurance, a reinsurance intermediary and consultancy. Together, these businesses have over 9,000 employees and 77 offices in 75 cities and 23 countries. More information about Towers Perrin is available at www.towersperrin.com.

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