Meet the newstock option

Stock options, the lottery-like payouts that created a new class of paper millionaires in the Internet boom, are fading in importance in the corporate world, often replaced by a stodgier type of compensation known as restricted stock.

Of the 10 largest public companies in Massachusetts, for instance, six have increased their use of restricted stock for compensation, frequently in place of options. The companies include consumer-products giant Gillette Co., retailer Staples Inc., and drug developer Biogen Idec Inc.

Last year defense contractor Raytheon Co. of Waltham quit paying out any stock options altogether, in anticipation of changes to accounting rules that will make it more expensive for companies to pay out options. In Natick, medical-devices maker Boston Scientific Corp. now awards some employees about one share of restricted stock for every three options they once were eligible to receive.

Options -- the right to buy company shares in the future at a fixed price, often one far below the actual value of the shares -- were awarded prodigiously by start-up technology firms in the 1990s because it was cheaper than paying employees in cash or other forms of compensation. If the company did well and the stock rose, employees and executives would be rewarded handsomely. Best of all, from a company perspective, the options cost nothing -- accounting rules did not require options to be considered as an expense, like salaries or office supplies.

But if a company did poorly, the options became worthless. Worse, in the minds of some corporate critics, options created perverse incentives for executives to drive up short-term stock prices at the expense of the long-term health of the company.

A combination of new accounting rules requiring the expensing of stock options and the stagnant markets of the past several years is driving many companies to replace options with restricted shares. Restricted shares, like options, usually can't be cashed in immediately. But because they are actual shares of the company, they always retain some value, even if stock prices fall, and are thus less risky for the employees.

David Pierce, marketing director for Boston Scientific's endoscopy business, said he can pay less attention to the day-to-day fluctuations in the value of his stock because of the change. Boston Scientific's stock has fallen 12.7 percent this year, for instance. Pierce says he still has long-term confidence in the company and its shares. But, he said, ''If it's going south, the restricted piece is a nice hedge."

In all, 40 percent of public companies are reconsidering their option plans, according to the National Center for Employee Ownership, a California research group. Nearly all companies award some options, the center says, but only about 25 percent extend below the top managers and only 15 percent of companies offer either restricted stock or options to most, or all, of their employees.

Compensation specialists say it's too soon to say whether this shift is good for employees overall. But many employees already had written off the options they got in the previous era, and don't mind seeing options go away.

Jessie English, a molecular biologist for drug maker Pfizer Inc. in Cambridge, said most of the options she was awarded at a previous employer were worthless and provided no incentive for her to stay when Pfizer made her an offer last summer. Pfizer's offer included restricted shares.

''The restricted stock is more important and more real," English said. Compared to stock options, she said, ''It's been true compensation."

The shift in corporate compensation plans is driven by accounting rules instituted as a way to rein in chief executive pay. Starting June 15, companies will be required to place a value on the expense of all stock options and other equity granted.

That can make a dramatic difference. For data-storage producer EMC Corp. of Hopkinton, for instance, including the value of all options would have reduced net income $363 million to $508 million last year, according to a securities filing.

The goal was to give shareholders a better sense of the cost of options payouts, which so far haven't factored into most earnings statements. That had made options the perfect currency for start-ups with feeble profits. But the options' off-the-books nature also fueled a backlash amid accounting scandals that led to the collapse of companies like WorldCom Inc.

Amid the debate, a few companies such as Microsoft Corp. started moving to replace options with restricted shares. Now, said compensation consultant Frank B. Glassner, ''It's not as easy as handing out monopoly money to the workforce anymore."

Congress and regulators are still hashing out how this rule will be implemented, and many technology executives still argue the change isn't needed. For some activists who first pressed companies to expense their options, the move to replace options with restricted stock seems a mixed blessing.

Paul Hodgson, senior researcher at the Corporate Library in Portland, Maine, which tracks governance issues, worries that the restricted stock, which has value at any price, will reduce executives' incentive to improve share performance.

A few companies say they're still prepared to pay as many options as in the past. One is Cambridge drug maker Genzyme Corp., whose chief financial officer, Michael S. Wyzga, said a change might create a backlash among employees. ''It would be disrespectful to chop off that portion of their compensation because of the [new] accounting," Wyzga said. In 2003, Genzyme chief executive Henri A. Termeer received options worth $35 million, assuming the stock price rises 10 percent annually.

Other companies say their workers won't mind the end of options. Of the 19,500 employees at State Street Corp., 3,000 were previously eligible to receive stock options. Recently, the company started issuing most of them ''deferred shares," which vest over time.

The restricted stock carries a face value of 30 percent less than the options they replace, and may help State Street reduce the $27 million charge it showed to cover costs of options and other long-term compensation in 2004.

But that's still a fair trade, said Boon Ooi, senior vice president, since the shares also carry less risk. ''We're not cutting people's compensation, we're just delivering it in a different form," Ooi said.

Ross Kerber can be reached at kerber@globe.com.