Editor

Letters

CAUGHT WITH OUR ZEROES DOWN
Your article on Mary Van Maren-Foley in the March 1998 issue observes that "in 1996, 284,000 premium cigars were sold in the United States to customers who forked over $800 million for the pleasure of smoking them." I knew that cigar prices had risen dramatically in the past few years, but I had no idea that the average premium cigar price had risen to the $2,816.90 that the statement implies. Ms. Van Maren-Foley and her husband must have made a real killing on their inventory.

--JAMES SKRYDLAK, MBA '75

Marietta, Georgia

000ps: What a difference a few zeroes make! Or so we discovered when we inadvertently dropped three of them. According to the Cigar Association of America, there were 284 million (not thousand) premium cigars sold in 1996--bringing the average price to an affordable $2.82 per cigar.

--Eds.

DOWN ON DOWNSIZING
Although I received my MBA degree before Professor Pfeffer arrived at the GSB, I have long been an admirer of his research and writing. I taught organizational behavior and human resources management at Drexel University for 10 years and now have a full-time practice in organization development and management consulting. Dr. Pfeffer's latest book, The Human Equation [March 1998], as well as its predecessor, Competitive Advantage Through People, provide a persuasive argument for adopting more enlightened human resources management policies, practices, and procedures, while eschewing the wrongheaded thinking of the practice of downsizing.
       Downsizing has been shown to be highly ineffective as a cost-cutting strategy or as a way of becoming more productive. If anything, when downsizing occurs it should be a red flag that management is incompetent at best and downright dangerous and out of control at worst.
       So here's my question and a suggestion: Given the hundreds of executives who attend the GSB's high-priced professional development programs and the hundreds more who complete the MBA, SEP, and Sloan programs annually, why aren't CEOs and managers heeding Dr. Pfeffer's advice? Are they exposed to Dr. Pfeffer's ideas? Are they listening? Someone at the Business School should do a better job at quality control and stop granting degrees and certificates to those who sim- ply may be incapable of "getting it." When I was there, if you didn't demonstrate some level of mastery of the subject matter, you didn't finish. This should be even more true today, when the skills to manage people effectively are more critical than ever, and failure to acquire and utilize such skills should be considered as management malpractice.

--WAYNE M. WORMLEY, MBA '75

Philadelphia, Pennsylvania

OPTIONS CAN BE COSTLY
Your March article on Professor Richard Lambert's research, "Stock Options Good Option for Startups," raises some valid points but doesn't tell the whole story. While Lambert convincingly argues that options can help to retain and to motivate a start-up venture's employees, no mention was made of having the discipline to know when to curb the rate of option grants. With em-ployee option grants, there really can be too much of a good thing.
       The dark side of liberal employee option grants is that they eventually can seriously dilute a company's per-share earnings. As a stock's price rises, employees may exercise the options they were granted, increasing the number of outstanding shares. Net income is then divided by this greater number of shares, potentially hurting earnings-per-share growth. The danger comes when a company can't improve net after-tax earnings fast enough to overcome this dilutive effect. This dilution is often called "overhang," and recent studies have shown the largest U.S. companies have already hit the 12 percent overhang point, double the level of five years ago. Technology firms are closer to 20 percent.
       When net income doesn't grow fast enough, the company has to repurchase shares in the marketplace to prevent dilution or suffer the wrath of existing shareholders and Wall Street. (You might have noticed that many companies have announced large-scale buyback programs for this very reason, and many have still not seen the overall number of outstanding shares decline.)
       The real squeeze comes when the company's momentum slows down. Imagine a scenario where you have stagnant or declining earnings and increasing numbers of options being exercised as people bail out. That's a double hit to earnings-per-share. Will the company have the resources to repurchase during tough economic times or the willingness to do so if the stock market isn't racing ahead?
       Professor Lambert is correct to argue for some level of overhang, particularly for start-up firms who must retain key employees and technology specialists. But he can't ignore the consequences down the road if an option-based compensation scheme continues undisciplined. Case in point: Microsoft spent 90 percent of last year's net after-tax income to buy back 80 percent of option-related shares that were issued in 1997. I certainly wouldn't want to be a Microsoft shareholder if and when the earnings growth slows.

--JOHN C. WILEN, MBA '84

Plano, Texas

Richard Lambert responds:
I agree wholeheartedly with Mr. Wilen's main point: Options, like any other form of compensation, have a cost. Beyond a certain point, granting more options does not increase their incentives by very much (and can even make some incentives worse), yet the costs to shareholders go up and up. Many companies are being criticized (and some deservedly so) for going too far with compensation packages that are bloated with megagrants of options.

We'd love to hear from you! Please send your letters to Stanford Business, Graduate School of Business, Stanford University, Stanford, CA 94305-5015 or gsb_newsline@gsb.stanford.edu. Letters may be edited for length.

Contributors

ROBBIE MCCLARAN: Robbie McClaran's work has appeared in publications such as the New York Times, Fortune, Time, and Newsweek. He has also photographed on assignment for Nike, Hitachi, and Microsoft, among other corporations. McClaran lives in Portland, Ore.

DAVID SHELDON: In addition to creating editorial art, freelance illustrator David Sheldon has worked on animation for Nickelodeon and on a line of baby products for Bath and Body Works. Sheldon wishes he had "even a quarter of the business savvy of the readers of this magazine."

JORDIN ISIP: Jordin Isip is a Brooklyn-based illustrator whose mixed-media images appear in period-icals and on book covers, posters, records, and CDs.

IRAIDA ICAZA: Originally from Panama, Iraida Icaza now works in New York City. She creates composite photographs for editorial publications and advertising campaigns internationally. Icaza is a graduate of the Rhode Island School of Design.

BRIAN CAIRNS: Brian Cairns is based in Scotland and reg-ularly wins awards for his work for clients such as the Atlantic Monthly, Time, Nike, Deloitte & Touche, and KPMG. His work has been exhibited in London, New York, Los Angeles, and Japan.