of stock options has turned into a weight that adds to employee malaise. While many employees may consider themselves lucky simply to have jobs,

the challenge for employers is figuring out how to alter options to obtain and retain the best managers without at the

same time infuriating

shareholders–and determining what to substitute for stock rewards going forward.

According to some surveys, the answer to the reward question is easy.

Give them cash. A February study of 682 workers by BridgeGate, an Irvine, Calif., high-tech executive search firm, found that half the

respondents preferred cash remuneration to stock options or other non-cash compensation, marking the first time in the survey's three-year

history that

cash beat out all alternative incentives combined.

What employees want, however, is not what they're likely to get. In a

revenue-short economy that is forcing most companies to focus more closely on balance sheets and cash flow, cash compensation is unlikely to

be seen as a wholesale recruiting and retention replacement for stock.

Baby-with-Bathwater Syndrome

Given the environment, a surprisingly strong number of compensation

consultants say that stock incentives are still a good idea and are not being abandoned.

"Stock option plans are alive and well in Silicon Valley and, I think,

everywhere else," says Diane Doubleday, an executive-compensation principal at benefits consultant William M. Mercer in San Francisco. "They

are not dead and gone at all."

Stock option proponents insist that the plans are still the best way to yoke

individual initiative to shareholder value, even if they are not sure things.

It may take a while for the shock of the current bear market to wear off,

because so many employees and the general public were lulled by the unprecedented bull market of the previous decade into

giddy exuberance.

When they realize that share volatility is a fact of life, however, they will once again welcome options as a good incentive, if not a sure-fire path to

riches.

Stock options are certainly holding their own as a pay incentive at

non-U.S. companies. Towers Perrin recently interviewed overseas executives about

their companies' compensation plans. By 2003, the benefits consultant predicts, long-term incentive plans, including stock options, will increase by

about 50% in Argentina, Germany, Italy and Spain, and they will more than

double in Japan, Mexico and South Korea.

Closer to home, employers would be wise to continue their options

programs and use them as educational tools to remind employees that options are meant as long-term rewards for strong performance.

"Employers are relieved to be able to focus employees' attention on long-term shareholder-value creation instead of instant wealth

accumulation," says Doubleday.

Sandra Sussman, executive director of the National Association of Stock

Plan Professionals in Concord, Calif., agrees. "The reality of volatility has brought people back down to earth," she says. "The challenge now is to

figure out how to make options a retention tool. Stock is a good long-term incentive. And that's what it was meant to be."

Daring to Reprice

Putting a sheen on options while many of them are still sunk in the mire is

the challenge, of course.

The conventional approach to refurbishing poorly performing options was to

simply cancel the old option grants and reissue a similar amount with lower strike prices. That worked until two years ago, when the Financial

Accounting Standards Board released its Interpretation No. 44. It forces companies to reflect the costs of repricing in their

earnings.

Moreover, when stock prices were soaring during the 1990s, investors took little notice of the few

companies that repriced options for their top

executives. Today, the practice is scorned. "Repricing is perceived by many to be inherently unfair to shareholders," says the NASPP's Sussman, "even

though companies may have their own valid reasons for coming down on the side of repricing."

Repricings still occur, but they are not necessarily sure things for the option

holders. One of the newer approaches to repricing is the "six-and-one" method. Under this treatment, options that are canceled can be reinstated at

the existing market price six months and one day after the cancellation. This frees the company from having to take the

FAS 44-mandated charge, but

does not necessarily mean that an option holder will be in better shape.

The six-and-one method has been used by Sprint and

RealNetworks, among others.

Other Options

A second alternative is to replace underwater options with fewer shares of

restricted stock. While this move does trigger an earnings charge, compensation consultants point out that the charge is fixed and amortized

over the vesting period. What's more, the charge is equal to the fair value of the restricted shares and is not subject to subsequent

changes in share

price.

This method, which has been used by Toys "R" Us and other companies,

offers employees a reduced risk of price declines and immediate retention value through vesting, while investors suffer lower dilution than in

conventional repricings. Some shareholders have grumbled, however, that immediate replacement amounts to a

something-for-nothing proposition.

Since it carries little performance-related risk, it defeats the purpose of performance-based incentives–to tie employees' economic future to

creation of value.

Another variation of the six-and-one method is shortening the remaining life

of underwater stock to six months, at which time new options are granted at the then market value. Another strategy is to do nothing and hope the stock

price rebounds, thus quelling worries that employees will demand a repricing or new grant each time stock prices

fall.

Legal Delicacies

Unless a company can make a compelling argument to existing

shareholders, however, tampering with already awarded option grants can be an invitation to lawsuits.

"It's important to have a sound, articulated business reason for undertaking

any option repricing program," says Andrew Liazos, a partner in the Boston law firm of McDermott, Will & Emory.

Companies undergoing workforce reductions may have a tough time

convincing shareholders of the value of selective repricing for top executives, he says. And if a company promises one type of repricing

action and then decides on another, it could create litigation risk. "It's prudent to demonstrate the benefit to the company in doing

the repricing or

when exchanging options for restricted stock," Liazos says.

Any company embarking on an option repricing program must make a

strong push to explain the decision through its investor relations and public relations areas. "Many [disasters] involve a failure to communicate and help

people understand the material terms of the agreements," says Liazos. "With the New Economy companies, a lot of folks

didn't pay attention to

these things, and now we're seeing the aftermath."

Employees also must be instructed on how option changes can affect their

net worth. "Keeping an eye on the volatility ball is going to be important,"

says the NASPP's Sussman. "So is making sure your employees are in the know and that there's a balance, because shareholders are keeping an eye on all this."

Another yellow flag is in the area of change-of-control vesting. "You have

to be precise in what you mean by sale of a company," says Liazos.

The regulatory landscape may change as well. The Securities and

Exchange Commission is accepting comment on proposed changes to its rules about disclosing equity compensation and explaining any dilutive

affects that repricings and exchanges may have. The New York Stock Exchange and the Nasdaq are also considering more

disclosure rules

regarding compensation plans.