CEBC IN THE NEWS

PIONEER PRESS

Stock Options for Rank and File

Published Sunday, October 17, 2004 in the Pioneer Press.

By Dave Beal

At Best Buy and Fastenal, executives have turned their stock or options into worker incentives.

Minnesota's corporate sector, long a source of innovative initiatives, is still spawning them. Case in point: stock options.

Top executives at two companies — Best Buy in Bloomington and Fastenal in Winona — have dreamed up a new way to drive benefits down to the troops. They are turning their stock into perks for the rank and file.

Ron James, president and CEO of the Twin Cities-based Center for Ethical Business Cultures, says such moves stimulate line employees to engage more with their top executives in company-wide efforts to perform better.

"This is a step that helps bring that relationship closer together," he says. "It's a powerful motivator."

At Fastenal, founder and chairman Bob Kierlin came up with the idea in 1999.

Brad Anderson, CEO at Best Buy, worked out his plan last year.

For Kierlin, the practice is part of his long-standing pattern of gradually reducing his holdings in the company. Before Fastenal went public in 1987, Kierlin held 51 percent of its stock. After that, his stake fell to 30 percent.

Since then, he has reduced his holdings much more, by giving away enormous amounts of the stock to schools, others and employees. When 2004 ends, his stake in the company will be down to 7.5 percent.

All employees who worked at Fastenal for more than three years were eligible for the new options created by Kierlin's stock gifts. Store managers with tenures less than three years also qualified.

The company estimates that half of the 3,000 employees at Fastenal have taken advantage of the plan, which has given $20 million in benefits.

At Best Buy, Anderson exercised no options in 2003, but he was entitled to a 200,000-share grant of new options. Instead of accepting the grant, he passed it on to non-executive employees last year. The options have a potential value of $7.5 million.

Last week, Best Buy reported that Anderson has redirected another batch of stock options granted to him — more than 150,000 additional shares — this time mostly to line employees involved in the company's "customer centricity" initiative to focus more on shoppers at certain stores.

Both of these executives' moves avoid a frequent downside of stock option plans: dilution of outside investors' stakes in the companies.

Champions of stock options argue that they motivate employees to perform better by giving them ownership. Investors counter that issuing more shares for options effectively cuts their stake, and that this loss outweighs any gain shareholders might realize thanks to the work of the more motivated employees.

Because Kierlin's and Anderson's shares weren't new, there was no dilution.

Keeping employees is another plus.

At Fastenal, retention of managers is up 30 percent since 2000. Reyne Wisecup, head of the company's human resources department, cites Kierlin's move to turn stock over to the employees as one of a number of factors accounting for the higher retention rate.

The two executives' handovers of stock to their workers have also enhanced the companies' images.

Ever since the early 1980s, CEO pay packages have risen far more rapidly than those of non-executive workers. While that has been good for the CEOs, it has made them vulnerable to harsh criticism from investors, journalists, employees, unions, regulators and elected officials.

Often, the result is clouds of cynicism that can't be dashed away by even the most competent public relations professionals.

Conversely, Brad Anderson's move generated good publicity for Best Buy. CBS Marketwatch, CNN and public television's Nightly Business News gave it favorable coverage.

Best Buy is reluctant to comment on Anderson's move, but others close to the company say it has gone down well with company officials.

"They feel very good about it," says Bruce Shnider, an attorney at the Dorsey & Whitney law firm who does work for Best Buy.

Such favorable publicity can translate into hard benefits for the company, according to studies cited by professors Joseph Piotroski and Abbie Smith at the University of Chicago Graduate School of Business.

They point to the impact of a full-page ad, which was critical of Sears Roebuck and Co. directors, that shareholder activist Robert Monks placed in the Wall Street Journal in 1992. The ad showed a silhouette of Sears directors, called them "the non-performing assets of Sears" and blamed them for the weak performance of Sears' stock.

Highly embarrassed, the directors decided to adopt many of Monks' proposals. Their moves attracted much attention from investors, thanks in part to widespread media coverage.

"The market rewarded these changes with a 9.5 percent excess return the day the changes were announced, and a 37 percent return the following year, increasing shareholder value," says an article in the school's latest "Capital Ideas" magazine.

Paul Hodgson, senior researcher at The Corporate Library, says he doesn't see anything wrong with the idea of top executives turning their options over to employees.

"It seems a praiseworthy action on the face of it," said Hodgson, whose organization does research on corporate governance and pay practices.

But he adds: "I would rather see more fundamental changes to corporate compensation policy overall." He suggests smaller option grants and stronger provisions to base them on performance.

Kevin Murphy, a University of Southern California professor who specializes in corporate pay practices, is skeptical. He wonders why directors don't simply grant the options straight to the rank and file in the first place.

"It's undoubtedly good PR," he says of the practice.

Shortly after Fastenal disclosed Kierlin's plan, CEO pay critic Graef Crystal predicted that it would not catch on. He was right.

Gary Locke, a managing director at the Towers-Perrin consulting firm in Bloomington, monitors compensation globally as head of the firm's executive pay and rewards practice.

Locke dialed into his databases and found only one other firm, Charles Schwab, where top executives gave up their options. Schwab's top two leaders did so two years ago, giving options to other officers to help retain them.

But Ron James adds that these moves, rare as they are even here, are far from the only initiative to come out of the Twin Cities corporate community over the years.

He ticks off the 2 percent and 5 percent clubs, for their encouragement of charitable giving by companies; the Caux Round Table,for forging worldwide ethical principles; and the 25 years of corporate support for his center.

Obviously, there have been problems. Yet overall, says James, it's pretty good here.

"It must be something in the water," he says.

© Copyright 2004 Pioneer Press. All rights reserved.

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