Columns

The Bottom Line

Taking stock of options

Deirdre McMurdy April 28 1997
Columns

The Bottom Line

Taking stock of options

Deirdre McMurdy April 28 1997

The Bottom Line

Columns

Taking stock of options

Deirdre McMurdy

Forget about robins and tulips. In Canada, executive salary disclosure has now become the official harbinger of spring. This year, stock options—and the vast new wealth they have created for senior managers—are in the spotlight.

Partly because of shareholder pressure to link pay with performance, a record number of North American companies now compensate their executives with options. Stock options allow their owner to buy shares at some point in the future at a fixed price. When the share price advances to—or beyond—that point, the options can be converted into stock and sold for a profit. As a result, last year’s raging bull market created a huge surge in compensation for executives who held options. Andrew Grove, the chief executive of Intel Corp., made $131.5 million in 1996 by exercising stock options. One of Canada’s highest-paid CEOs, Laurent Beaudoin of Bombardier Inc., made $19 million, of which $17.5 million came from cashing out options.

At a time of wide disparities between rich and poor, the subject of executive pay has become more touchy than ever in Canada. Canadians have a stubborn egalitarian streak, and there is growing concern about the gap between the soaring fortunes of corporate leaders and workers.

But what exactly is someone’s market value? How can that best be measured? Is it possible to differentiate between luck and personal contribution?

Until stock options generated such extravagant profits, most boards and investors considered them by far the best solution to those problems because they clearly linked the value of leadership with stock price performance and, presumably, the best interests of the company’s shareholders. In Canada—where executives typically earn about 37-per-cent less, before taxes, than they would in comparable positions in the United States—generous use of stock options also allow employers to compete for top talent in an international market.

At a time of wide disparities between rich and poor, the topic of executive pay is hotter than ever

Still, there are some increasingly apparent drawbacks to the widespread use of stock options.

First, they can dilute the value of existing shares in the company because the same base of earnings and dividends must be spread among more hands. The Toronto Stock Exchange greatly increased that risk of dilution three years ago when it lifted a rule which had limited the total number of stock options issued by a company to 10 per cent of its outstanding common shares. Companies can now grant as many options as a board of directors deems appropriate.

A second drawback is that, in a squeeze, boards of directors seldom hold a hard line on option pricing. If a company’s stock price slumps for an extended period, the board will often lower the bar by revising the so-called strike price-the price at which the options may be exercised. That effectively decouples pay and performance—and undermines the rationale for issuing options in the first place. Finally, the excessive use of stock options reinforces the already intense focus on share prices. North American investors have become accustomed to quarterly—if not instant—gratification from their holdings. And that has greatly contributed to this decade’s mania for corporate downsizing and narrow focus. Layoffs and asset sales, for example, have become one of the most efficient ways to boost stock price in recent years.

But somebody has to maintain a balance between short-term considerations—such as the share price—and longer-term objectives. Now that most of the quick fixes and corporate contractions have taken place, and the business cycle is on an upswing, it is once again time for a renewed focus on building and expansion. However, growth entails risk and uncertainty—two things that markets consistently punish. And with so many stock options now in the hands of those who are supposed to make broad strategic decisions, it remains to be seen whether their emphasis on short-term gain in the market will mean long-term pain for everyone else.