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Home > Stock Options > Articles Online >
During the last several months, the issue of stock options, especially for top executives, has become a front-page national issue. Unfortunately, this debate has often been fueled more by gut reactions than data on just what makes stock options work or fail. Do stock options align employee and shareholder interests while providing everyday workers with a stake in the system? Or are they just a way to disguise costs, provide excessive rewards to people already excessively rewarded, and give CEOs a reason to play games with earnings? It turns out they are all of these things. Stock options have gone from a relatively obscure and usually small part of executive compensation to an often unearned windfall of staggering proportions. At the same time, they have been extended downward. We estimate that while just one million employees got options in 1992, 10 million do today. Between 20% and 25% of public companies now make options available to most or all of their full-time employees, and some extend them to part-timers as well.
Contrary to popular mythology, it's not just technology companies that have extended options to ordinary workers, although almost all technology companies do have these plans. In fact, most employees getting options today work for large, publicly traded non-technology companies, such as Whole Foods, Southwest Airlines, Starbucks, and many others. These plans have provided significant financial benefits to non-executive employees in the past, and no doubt will again when the market recovers. Most companies now give out options on a periodic basis, so while employees have some options that may never regain any value, they will also get new options at low prices that will have value in the future. While the growth of broad-based options has been an important economic trend, our data nonetheless indicate that even in plans that do share options widely, executives still get an average of 65% to 70% of the total options granted.
A recent study by Douglas Kruse and Joseph Blasi at Rutgers University found that over a three-year post-plan period, companies that grant options to most or all employees show a 17% improvement in productivity over what would have been expected had they not set up such a plan. Their return on assets goes up 2.3% per year over what would have been expected, while their stock performance is either better or about the same than comparable companies, depending on how performance is measured. But these were companies that granted options broadly. Most of the comparison companies in the study grant options to key people only; clearly, they do not do as well. In fact, Blasi and Kruse subsequently found that concentrating ownership in executives is related to lower corporate performance, while Robert Grams, summarizing 228 studies on the subject, found no consistent relationship between greater equity grants to executives and stock prices.
Many of the advocates for stock options use the fact that they are now a benefit for ordinary workers to defend stock options against the various slings and arrows now being launched at them politically and economically. Putting executive and non-executive options in the same justification boat, however, is misleading. Options for ordinary employees can work out to a new car, college tuition, a down payment on a house, a great vacation, and maybe even a more secure retirement. Options for executives can amount to enough money to fund a small nation. The option packages some executives have received would amount to tens of thousands of dollars per employee in their company.
The incentives created by these wildly differing amounts are not comparable. For everyday employees, options are a reward for sharing ideas and information, for working harder, and for paying more attention to quality and customer satisfaction. The collective efforts of these employees can have a dramatic impact on corporate performance. Indeed, every CEO these days says that employees are the company's greatest asset. Based on the Rutgers data, shareholders have no gripe about broad-based options. But mega-grants to executives are another story.
If these grants are not specifically tied to above-average corporate performance, then they clearly are not rewarding executives for much more than living and breathing in a strong market. Just about everyone agrees that executive pay needs to be more carefully structured to avoid this. But mega-grants even in successful companies can be problematic too. Executives who can make decisions about the company's future have a real incentive to make the stock price more volatile. An option typically allows the executive to buy stock at a price fixed today for 10 years into the future. A stock that gyrates way up and falls way back down is a more valuable one to have than option on stock whose performance is more steady because the executive can exercise the option at high points and ignore low ones. Huge grants make this temptation hard to resist, not to mention the temptation to cheat outright. More modest grants to executives would help them focus on other corporate than short-term earnings. Prohibiting executives from exercising their options until they expire or the executives leave (as is more common in Europe) would also secure a more long-term focus.
In 2004, the National Center for Employee Ownership (NCEO); the Beyster Institute at the Rady School, UC San Diego; and the Global Equity Organization (GEO) created the Committee for Effective Employee Ownership (CEEO). The CEEO's primary goal is to devise principles intended to help companies and investors make appropriate, economically sound choices about the distribution of equity among employees. In addition, the CEEO seeks to provide general guidelines on how companies can best use broad employee equity ownership plans to create more productive and rewarding workplaces. The CEEO based each of the principles in this document on objective research by scholars, advisors, and the National Center for Employee Ownership; the principles are not simply our opinion or philosophy. The principles focus on a few key points:
Corey Rosen is the NCEO's executive director. He can be reached at CRosen@nceo.org.
Copyright © 2005 by The National Center for Employee Ownership (NCEO) (phone 510/208-1300; email nceo@nceo.org; WWW http://www.nceo.org/). All rights reserved.
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