The Performance of Stock Options
When Options Rise to Top, Guess Who Pays. By Gretchen Morgenson. [New York Times: Business]
Joseph R. Blasi and Douglas L. Kruse, professors of human resource management at Rutgers, examined stock option grants and shareholder returns at the 1,500 largest American companies from 1992 to 2001. They found that companies dispensing significantly larger-than-average option grants to their top five executives produced decidedly lower total returns to shareholders over the period than those dispensing far fewer options...
The 375 that gave the most to their top executives — more than 40.8 percent of all options — performed worst, returning 22.5 percent over all to shareholders through 2001. The 375 companies that gave the fewest options to their senior executives — less than 19 percent — fared the best, giving investors a 31.3 percent return, on average.
Options are the only proven compensation incentive to generate long-term performance. The problem is that in practice, this study shows, the distribution of options is heavily skewed towards executives over employees. What's worse, its a pattern of systemic complicity that will be hard to reform:
"The assumption that the system is better for everybody by giving most of the pie to the top of the hierarchy is an assumption that is widely accepted by lawyers, accountants, Wall Street investment bankers and even by many academics," Mr. Blasi said. "But when you compare companies against each other, the more you increase the option grant to the top five executives above the mean, the worse your shareholder return gets."
The tech industry has a history of distributing a greater share to the rank-and-file. Unfortunately the industry is loosing the options accounting battle. Options will be expensed. The valuation game that remains, of how options are priced, is yet to be determined. But the larger corporate governance issue looms, relying on institutional investors to pressure executives to distribute options to the very people that need motivation. Lets hope the baby doen't get thrown out with the bathwater.