Apple computer stock

The cracks are beginning to show in the stock-option edifice built by Silicon Valley over several decades.

Apple Computer Inc.'s Steve Jobs is handing back 27.5 million underwater option shares and is taking in return, not more option shares with a lower strike price but 5 million free shares.

The company filed its planned exchange with the Securities and Exchange Commission under the headline: "Apple Enhances Corporate Governance."

To use a favorite phrase of Matthew Ward, head of Westward Pay Strategies, a San Francisco-based compensation-consulting firm, giving Out free shares is what the "Stodgecos" (stodgy companies) do. Until now, it's not something That those swashbucklers Out there in the Valley would even deign to consider.

In January 2000, Apple's board handed Jobs an option grant covering 20 million shares and carrying a strike price of $43.59 a share. Shortly after the grant was made, I estimated its value at $471 million.

Apparently, an option of that size didn't stir Jobs to new heights of performance. On the contrary, he fell on his face, with the stock price plummeting to $18.30 a share by Oct. 19, 2001. It was on that latter date that Apple's board decided that he needed more motivation. So he was handed a second option grant, this one covering 7.5 million shares and carrying a strike price of $18.30.

Alas, that second grant was yet another instance of trying to ignite wet straw. By this March 20, Apple's stock had declined further, to $14.91.

It was at this point that the board, and Jobs, threw in the towel and agreed to exchange 27.5 million underwater option shares for 5 million free shares, worth at the time of their grant, $74.6 million.

By my estimation, the value of his two option grants, measured at the time of their grant, was about $523 million. By March 20 this year, the present value had declined to about $89 million. Allowing for some elasticity in the assumptions that go into the Black-Scholes option-pricing model, exchanging $89 million of underwater options for $75 million of free shares is pretty much an even exchange.

Comparing his 5 million free shares to his 27.5 million option shares, if Apple's stock price were to rise to $44.85 a share, just about what it was in January 2000 when he received his first grant, he would break even between the two alternatives.

If the stock price rose above $44.85, he would be shown, in retrospect, to have been foolish in making the exchange, because the 27.5 million option shares would be worth more than the 5 million free shares. On the other side of the price spectrum, any future price less than $44.85 would vindicate his judgment in taking the 5 million free shares.

As for Apple's other 10,210 employees, they are being offered the opportunity to turn in their underwater options and receive in return lesser numbers of new option shares carrying as a strike price whatever the market price is six months and one day hence.

Of course, it's doubtful anyone gave the employees a choice. The real reason for the difference in treatment is that free shares involve a charge to earnings equal to the value of the shares at the time of the grant, while option shares, at least for now, don't carry any charge at all.

So, in the view of Apple's board, if you have limited capacity to take charges to earnings, you first take care of the field marshal. Then, if there's anything left over, which in this case, there isn't, you leave the troops to fend for themselves.

Graef Crystal is a columnist for Bloomberg News.