Stock Options Problems

Stock Options Problems

Firms have begun deemphasizing stock option plans, for several reasons. Many blame enormous stock options in part for incentivizing questionable managerial decisions and for helping to trigger the numerous corporate scandals in the past few years. Recently, many companies have had to explain why they often backdated their stock option grants thus enabling some executives to make exquisitely well timed stock option acquisitions. Furthermore until recently most companies did not treat the stock options they awarded as an expense. (So while the stock options were very much a part of each manager’s compensation the cost of those stock options didn’t show up as an expense on the companies’ financial statements) Today, regulatory reform means more companies are expensing stock options. This reduces to some degree the attractiveness to the companies of awarding the options. As one compensation consultant out it the fact that this is now costing them something wile mean that they will have to do more of the cost / benefit analysis to see what [compensation plan] design will give them the best return for their dollar.

Finally, too many stock options can be too much of a good thing. Executives with increasingly large stock option holdings have an added incentive to undertake riskier business strategies. Their options provide an incentive to go for spectacular results, but since they have not actually bought the stock yet, they don’t risk their own money. The solution is to draft the option plan so it forces recipients to convert their options to stock more quickly.

Broad Based Stock options

Plans for key employees (such as top executives) typically provide for a very significant upside in the value of stock the employee can receive. On the other hand, more companies today are implementing broad based stock option plans in which the potential appreciation is relatively modest, but in which all or most employees can participate. The basic thinking here is that most employers rely on empowered self motivated employees and that sharing ownership in the company with employees therefore makes motivational and practical sense.

Recently, several companies including Time Warner, Microsoft Aetna, and Charles Schwab announced they were discontinuing distributing stock options to most employees. Some of them, including Microsoft are instead awarding stock. With companies how having to show the options as an expense when awarded firms like Microsoft apparently feel awarding stock instead of stock options is amore direct and immediate way to link pay to performance.

Other plans

There are several other stock related long term incentive plans. Stock appreciation rights permit the recipient to exercise the stock option ( by buying the stock) or to take any appreciation in the stock price n cash, stock or some combination of these. A performances achievement plan awards shares of stock for the achievement of predetermined financial targets, such as profit or growth in earnings per share. With restricted stock plans, the firm usually wards shares without cost to the executive: The employee can sell the stock (for which he or she paid nothing) but is restricted from doing so for, say, five years. Under phantom stock plans, executives receive not shares but units that are similar to shares of company stock. At some future time, they receive value (usually in cash) equal to the appreciation of the phantom stock they own. The New Workforce illustrates some global aspects of the executive pay issue.

Other Executive Incentives

Golden parachutes

Payments companies make in connection with a change in ownership or control of a company.

Companies also provide various incentives to persuade executives to remain with the firm. This is especially important when there is reason to believe the firm is being stalked by another company that wants to buy it. The target company might then install golden parachute incentives. Golden parachutes (as opposed to golden handcuffs) are extraordinary payments companies make to executives in connection with a change in ownership or control of a company. For example, a company’s golden parachute cause might state that, should there be a change in ownership of the firms; the executive would receive a one time payment of $2 million. Under IRS regulations companies cannot deduct al golden parachute payments made to executives and the executive must pay a 20% excise tax on the golden parachute payments.