Stock options grew enormously in the 1990s as a financial tool to align the interests of corporate executives and managers with shareholders.

But now, some experts say companies went overboard with granting options, creating a financial boon for corporate executives, but a potential threat to investors through stock-option dilution, or "overhang."

This dilution happens when stock options, which typically number in the millions, are exercised and become full-fledged shares that are traded on the stock market.

Mixing these new shares with existing shares can depress a stock price, said Carol Bowie, director of governance research services with the Investor Responsibility Research Center in Washington. Said another way, after options are exercised, a company's profits have to be divided between the old shares and the newly created shares. Stock options are given to executives and managers at set prices; when the stock price goes up, they can sell them, making a profit.

Attempting to measure the threat of potential dilution from stock options, the center has ranked more than 1,000 U.S. companies by their stock options and stock option plans. The rank includes options granted but not yet exercised and those that could be granted in the future through board-approved plans.

The organization based its ranking on the corporate filings to the Securities and Exchange Commission before a company's 2001 shareholder meeting. The ranking is part of a 194-page report published in February and sold mainly to institutional investors.

Nationally, technology companies - such as PeopleSoft Inc., Vitesse Semiconductor Corp., Gateway Inc., Siebel Systems Inc., and Broadcom Corp. - had the highest potential of dilution from stock options, according to the report.

One company in the Philadelphia region ranked high on the list: home-builder Toll Bros. Inc., at 11th, with a potential dilution of 55.5 percent. The median dilution for U.S. companies was 14.1 percent, according to the center.

Other potential higher-dilution companies in the area were Sungard Data Systems Inc., Kulicke & Soffa Industries Inc., Quaker Chemical Corp., Systems & Computer Technology Corp., J&J; Snack Foods Corp., and Checkpoint Systems Inc., according to the center. Much of this potential dilution came from options that could be granted in the future.

Joel Rassman, chief financial officer at Toll Bros., and two executives from Quaker Chemical said they believed the ranking was misleading and overstated potential dilution.

For instance, the center's data do not consider historical patterns in granting stock options at a company, they said. In addition, just because a company has options available to grant several years into the future does not mean the company will grant them, they said.

"We don't think it's a fair evaluation," Rassman said of the report. Toll's dilution, based on Rassman's method of calculation, was about 16 percent. That does not include options contained in board plans that could be granted in the future.

Companies in the region with low levels of potential dilution included DuPont Co., Comcast Corp., American Water Works Co. Inc., Teleflex Inc., Vishay Intertechnology Inc., and Philadelphia Suburban Corp., according to the report. These companies had potential dilution of less than 6.5 percent, the group said.

Ira Kay, a director for compensation consulting at Watson Wyatt Worldwide in New York, said a Watson Wyatt study of stock options concluded "that too many companies have too many stock options authorized." The companies with the highest stock option exposure in a given year "do not generate the highest returns to shareholders," he said.

In the 1990s, stock options "had such favorable accounting treatment that people just kept on piling on more and more of them, and they did not worry about the cost," Kay said.

Companies see it differently. They say they believe stock options, when doled out with discipline, do what they are meant to - encourage executives to work hard and make tough decisions to get the stock price up - and they say they believe current criticism of options is unfair.

"We think [stock options] motivate the right behavior" from managers, said Joseph W. Bauer, president and chief operating officer of Quaker Chemical in Conshohocken.

Michael F. Barry, Quaker's chief financial officer, said the company believes its stock option plan is not overly dilutive and "in a reasonable range" when compared with other companies' plans. Based on his calculation, Quaker had a dilution from stock options of 11 percent in the year the research center analyzed the company's data, Barry said. This calculation does not include options that could be granted in the future.

"Properly structured stock option plans are an incredible incentive plan to get employees to perform," Rassman said. "Our plans have been incredibly shareholder-friendly."

About 600 of Toll Bros.' employees own stock options, he said. The company has 2,725 employees, including 112 executives, according to its regulatory filing with the SEC.

Thirty-five percent of Toll Bros.' stock is owned by corporate insiders, including brothers Robert I. and Bruce Toll, Rassman said. Company officers do not engage in stock-options practices that ultimately would be harmful to themselves as shareholders, he said.

On average over the last four years, Toll has granted 1.26 million stock options per year to employees. But the company also has purchased an almost equal number as part of a stock buyback plan, which eliminates dilution, Rassman said.

Toll's stock option plans have helped keep employees motivated and focused on earning profits, and has strengthened employee loyalty, Rassman said.

"We have very low turnover for our industry, in particular in middle management and upper management," Rassman said. Stock options are a "great retention carrot... . We don't know of any other vehicle that does what options do, even though there is all this pressure to relook at options."

Toll's share price has risen from $15.50 in May 2001 to close at $26.75 yesterday, mostly because of the sustained boom in housing sales. In March, the company split its stock. By regulation, options also were split.

With the current criticism, the company may be forced to reduce the number of stock options it grants to employees, Rassman said.

Peter Huang, an assistant professor of law at the University of Pennsylvania, suggested a different incentive formula for executives. He proposed linking the stock options to both a company's share price and another economic measure, such as market share of a company's product. Stock options also could be pegged to the company's share price over one or two years, he said.

Kay, the consultant from Watson Wyatt, said corporate compensation likely would undergo significant changes that de-emphasize stock options. The stock portion of an executive's compensation could include stock the executive is required to buy at market prices, stock grants, and stock options, he said.

In general, investors "should be more favorably disposed toward companies where executives own a lot of stock, where they have bought or are buying the stock, and where they are holding the stock and willing to announce ahead of time that they are going to sell," Kay said.