Executive Stock Option Plans
"If the company does not do better than its competitors, but the stock market goes up, executives do very well from their stock options. This makes no sense." Discuss viewpoint. Can you think of alternatives to the usual executive option plan that take the viewpoint into account?
Executive stock options are performance-based incentive plans that became popular in the 1950s and 1960s. They declined due to the stock market crash of the 1970s, but returned aggressively returned in the 1990s (Kole, 1997). Today, most companies grant stock options to their top officers as part of executive compensation, along with salary and bonuses. Options that are awarded as part of a compensation package can be very valuable to executives when stocks are performing well. The challenge comes in when stock value is realized for executives even when a company is not faring well at all. This is problematic.
In general, long-term incentive compensation for executives may include basic stock option rights, restricted stock grants, and cash payouts from long-term incentive plans (Parrish, 2008). An option award is basically the right to purchase company shares at a fixed price. Most vest over a 3-5-year period. Restricted stock awards for executives involve the restricted resale or transfer of a fixed quantity of shares that have forfeiture clauses invalidating the award if the executive voluntarily or involuntarily leaves an organization before the restrictions lapse. General stock options are much more flexible; restricted stock award redemption has greater constraints and as a result, less incentive value to the executive.
In the mid-1990s, nearly one-third of executive compensation was in the form of basic stock option awards vs. one-fifth during the 1980s (Kole, 1997). In recent years, stock-based remuneration has come to comprise the most profitable portion of executive pay. The original idea was that the value of options would rise parallel to stock market price increases. In most cases, the options have no value if there is no rise in share price. Hence, many publicly traded companies and investors regard options as one of the best compensation strategies for attracting top talent and incentivizing executives to perform well, aligning their interests with those of shareholders (Hess, 2012). However, this interest alignment does not always occur.
Opposing Points-of-View
There is much debate regarding the ethics and ultimate value of stock-based remuneration for CEOs and other corporate executives. In particular, many investors, politicians and academics have grown critical of this form of compensation when executives are able to walk away with large stock awards in underperforming companies (Hamilton & Wise, 2008). They cite this as reward for mediocre performance. Defenders of options argue that most companies grant options judiciously and that it is the most effective means of attracting top managers and leaders (Wade et al., 1997). With aggressive competition for talent, executive salaries continue to rise across industries. Stock options, advocates say, is the best way for more cash strapped organizations to lure in highly qualified executives.
One serious criticism however, is that stock option grants can incite executives to engage in actions that ultimately provide a short-term boost in company stock. Public corporations make it more enticing for CEO's to seek short-term gains that produce stock price spikes (Wyld, 2010). This can be detrimental to an organization in the long run. Corporate scandals such as the Enron incident have brought executive compensation and stock options under the microscope. According to Cicero (2009), "...the scandals at Enron, Tyco and other corporations have alerted investors...to how severely [executive] stock option plans can dilute both their stakes and their companies' earnings." The Sarbanes-Oxley Act of 2002 was created to ensure ethical accounting practice and improve regulation of corporate governance. Compliance is mandatory for all firms, both large and small. Yet, despite the presence of such new regulation and penalties executives may still manipulate the exercise of options to their personal benefit based on their personal knowledge of the organization (Collins et al., 2009). Many executives exercising stock options often avoid selling shares on the open market. They may utilize other alternatives such as selling the shares back to the company or holding them for the long-term (Cicero, 2009).. The assumption that stock options will be sold in the open market may skew interpretations about the practice and cost of options as part of total executive compensation.
Many firms are forced to address such concerns by including executive stock options on corporate financial statements because of the potential impact they can have to the financial health and prosperity of an organization...
Our semester plans gives you unlimited, unrestricted access to our entire library of resources —writing tools, guides, example essays, tutorials, class notes, and more.
Get Started Now