Compensation: Incentive Plans: Stock Options

Options earnings scheme, Employee stock option - Wikipedia

Stock options were just a footnote. Now the reverse is true.

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  3. Compensation: Incentive Plans: Stock Options The "right" to purchase stock at a given price at some time in the future.
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With astounding speed, stock option grants have come to dominate the pay—and often the wealth—of top executives throughout the United States. Michael Eisner exercised 22 million options on Disney stock in alone, netting more than a half-billion dollars. In total, U.

Overview of UK Share option Schemes

It would be difficult to exaggerate how much the options explosion has changed corporate America. But has the change been for the better or for the worse?

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Certainly, option grants have improved the fortunes of strategy 5 minute deals trading individual executives, entrepreneurs, software engineers, options earnings scheme investors. Their long-term impact on business in general remains much less clear, however. Option grants are even more controversial for many outside observers. The grants seem to shower ever greater riches on top executives, with options earnings scheme connection to corporate performance.

They appear to offer great upside rewards with little downside risk.

Employee Stock Option (ESO)

And, according to some very vocal critics, they motivate corporate leaders to pursue short-term moves that provide immediate boosts to stock values rather than build companies that will options earnings scheme over the long run. As the use of stock options has begun to expand internationally, such concerns have spread from the United States to the business centers of Europe and Asia.

Options do not promote a selfish, near-term perspective on the part of businesspeople. Quite the contrary. Options are the best compensation mechanism we have for getting managers to act in ways that ensure the long-term success of their companies and the well-being of their workers and stockholders. Stock options are bafflingly complex financial instruments. As a result, companies often end up having option programs that are counterproductive.

I have, for example, seen many Silicon Valley companies continue to use their pre-IPO programs—with unfortunate consequences—after the companies have grown and gone public.

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The Pay-to-Performance Link The binary options manual goal in granting stock options is, of course, to tie pay to performance—to ensure that executives profit when their companies prosper and suffer when they flounder.

Many critics claim that, in practice, option grants have not fulfilled that goal. Executives, they argue, continue to be rewarded as handsomely for failure as for success. As evidence, they either use anecdotes—examples of poorly performing companies that compensate their top managers extravagantly—or they cite studies indicating that the total pay of executives in charge of high-performing companies is not much different from the pay of those heading poor performers.

The studies are another matter. Virtually all of them share a fatal flaw: they measure only the compensation earned in options earnings scheme given year. As executives at a company receive yearly option grants, they begin to amass large amounts of stock and unexercised options. When the shifts in value of the overall holdings are taken into account, the link between pay and performance becomes much clearer. By increasing the number of shares executives control, option grants have dramatically strengthened the link between pay and performance.

Compensation: Incentive Plans: Stock Options

For both measures, the link between pay and performance has increased nearly tenfold since Tying Pay to Performance Given the complexity of options, though, it is reasonable to ask a simple question: if the goal is to align the incentives of options earnings scheme and managers, why not just hand out shares of stock? The answer is that options provide far greater leverage.

For a company with an average dividend yield and a stock price that exhibits average volatility, a single stock option is worth only about one-third of the value of a share. The company can therefore give an executive three times as many options as shares for the same cost.

In addition to providing leverage, options offer accounting advantages.

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The accounting treatment of options has generated enormous controversy. On the other side are many executives, especially those in small companies, who counter that options are difficult to value properly and that expensing them would discourage their use. The response of institutional investors to the special treatment of options has been relatively muted.

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They have not been as critical as one might expect. There are two reasons for this. First, companies are required to list their option expenses in a footnote to the balance sheet, so savvy investors can easily figure option costs into expenses. Even more important, activist shareholders have been among the most vocal in pushing companies to replace cash pay with options.

In my view, the worst thing about the current accounting rules is not that they allow companies to avoid listing options as an expense.

How Do Employee Stock Options Work?

That discourages companies from experimenting with new kinds of plans. As just one example, the accounting rules penalize discounted, indexed options—options with an exercise price that is initially set beneath the current stock price and that varies according to a general or industry-specific stock-market index.

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Although indexed options are attractive because they isolate company performance from broad stock-market trends, they are almost nonexistent, in large part because the accounting rules dissuade companies from even considering them. The idea of using leveraged incentives is not new.

What You Need to Know About Stock Options

Most salespeople, for example, are paid a higher commission rate on the revenues they generate above a certain target. Such plans are more difficult to administer than plans with a single commission rate, but when it options earnings scheme to compensation, the advantages of leverage often outweigh the disadvantages of complexity. You also have to impose penalties for weak performance.

The critics claim options have unlimited upside but no downside. The implicit assumption is that options have no value when granted and that the recipient thus has nothing to lose. But that assumption is completely false.

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Options do have value. Just look at the financial exchanges, where options on stock are bought and sold for large sums of money every second. Yes, the value of option grants is illiquid and, yes, the eventual payoff is contingent on the future performance of the company. But they have value nonetheless.

Employee Share and Share Option Schemes: In-depth

And if something has value that can be lost, it has, by definition, downside risk. In fact, options have even greater downside risk than stock. Consider two executives in the same company. One is granted a million dollars worth of stock, and the other is granted a million dollars worth of at-the-money options—options whose exercise price matches the stock price at the time of the grant. The executive with options, however, has essentially been wiped out. His options are now so far under water that they are nearly worthless.