Best Buy cuts back on use of executive stock options

Best Buy Co. Inc.'s stock options for its top executives are not only underwater but perilously close to drowning.

Until now, 75 percent of the Richfield-based retailer's long-term stock plan consisted of options, an unusually high percentage for a retail chain struggling to grow sales.

Over the past two years, the company's shares have lost more than half their value, closing Friday at $22.33. That means if Best Buy's current price continues to stagnate or fall in the years ahead, options held by the company's current and former top executives to purchase millions of shares will be worthless, or "underwater," according to a Star Tribune analysis.

"Options are clearly more valuable when you have a growth company," said Matt Melone, a professor of law and finance at Lehigh University in Pennsylvania. "Ten years ago, Best Buy was a booming company. Today, it's the opposite."

The company's core consumer electronics business has shrunk, and Best Buy has ceded market share to Wal-Mart and online competitors like Amazon. Best Buy's board of directors is also investigating allegations that former CEO Brian Dunn, who resigned suddenly earlier this month, used company assets to carry on an inappropriate relationship with a female employee.

The company declined to comment.

Like many companies over the past decade eager to cash in on a booming stock market, Best Buy had embraced stock options to attract and retain key talent. Simply put, stock options grant the user the right to purchase a certain amount of stock at a specific price. When the stock rises, executives can profit handsomely because they can acquire shares at locked-in prices that are significantly below the trading price.

Take CFO James Muehlbauer. On April 10, Muehlbauer's right to purchase 16,875 shares at $34.18 per share expired. But Muehlbauer didn't buy anything because Best Buy stock closed that day at $21.32, about 38 percent lower than the option price.

In fact, a review of Best Buy's proxy statements over the past eight years shows that only three executives have exercised any options: Dunn, former CEO Brad Anderson, and former executive vice president Darren Jackson, now the CEO of Advance Auto Parts.

Normally, stock options expire 10 years after they were granted, which means many of Best Buy's current executives still have plenty of time to boost the stock price before their options expire between 2013 and 2021.

When it comes to stock options, executives "all think they can make the stock price go up," said Scott Rollin, founder and president of Management Compensation Resources consulting firm in Edina. "Whether it does or not remains to be seen."

For example, Best Buy International chief Shari Ballard's options to purchase 32,325 shares at $39.59 per share expire in November 2013. That means Best Buy stock would need to rise more than 45 percent over the next 18 months for Ballard to make any money. But it would be unusual for a stock to jump that much. The S&P 500 index finished 2011 flat: So far this year, the index is up over 11 percent.

To fix this problem, the board last fall approved major changes to its "Long Term Incentive Program," according to documents filed with the Securities and Exchange Commission. Under the old plan, Best Buy's CEO and executive vice presidents received a combination of 75 percent stock options and 25 percent restricted stock. By contrast, Target and Starbucks offer their executives a mix of 50 percent options, 50 percent restricted stock.

Best Buy's revamp calls for top executives' stock awards to consist of 33 percent stock options, 33 percent restricted stock and 33 percent performance shares based on benchmarks such as return on invested capital and net earnings. Stock options now vest, or come into effect, on a three-year schedule instead of four years.

"The objective of the redesign is to provide recipients, including all officers, with market-competitive grants that create both a short-term and long-term vested interest in the success" of the company, the SEC document says.

Companies have been gradually moving away from stock options in the face of a declining stock market and increased government regulation. But Best Buy's retreat from options is also a tacit admission that the retailer no longer sees itself as the high-growth business it has long pitched to investors, analysts say.

Best Buy has long portrayed itself as a fast-growing high-tech firm vs. a mature chain of brick-and-mortar stores. So stock options, which normally encourage executives to take big risks to boost the stock price, would seem like the right compensation tool. Best Buy, however, has become a large, bureaucratic company that shies away from risk and change, former executives say.