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Benefits and Pensions MonitorA Second Look At Stock Options
These days, saying that you still believe in the importance of stock options is a lot like saying that you still believe in the tooth fairy. Stock options, according to the popular wisdom, are a remnant of the greedy 1990s and are muttered in the same breath as the dot-com boom and Enron. But we really shouldn’t dismiss stock options so readily. When you get right down to it, what better way is there to motivate employees than to give them a piece of the corporate pie? Giving your employees stock options should make them partners in a company’s growth. Employees are supposed to be motivated to act like owners, spurring innovation and performance. Granting widespread stock options sends the message to everybody that they have an impact on the growth of their company and they will be rewarded for that impact. Employees who are also stock owners should also stay at their company for a longer time, reducing the costs associated with employee turnover and helping their company retain necessary skill sets.
Heavily Misused The second poor application of this tool came about through the endless repricing of the options that some executives received. Dropping the price that options would be granted at effectively eliminated the entire idea of profit participation if, and only if, the company profited as well. Of course, the most widely held problem with stock options was how a company should value them on their books. At least on this matter things are getting better. In an article in the First Quarter 2005 issue of the Journal of Investment Management, Fayez A. Elayan, Kuntara Pukthuanthong, and Richard Roll looked at the 140 publicly-traded U.S. firms that announced their intention to recognize an accounting expense when stock options were granted to employees. They compared the stock market’s reaction to the many similar firms that elected not to expense options. They found that there was no evidence that expensing options reduced the stock price of a company. Instead, they found significant price increases for firms electing to expense options and significant price declines for similar firms that did not announce expensing at the same moment. Something To Hide So, just deciding to expense options won’t necessarily make your company profitable overnight. Stock options are only a part of overall corporate performance. And, giving people stock options doesn’t necessarily convert them into long-term holders of your company’s stock. Numerous studies have shown that most option holders sell their stock after they exercise their options. Option holders are often seeking to lock in their profits and take the cash rather than keeping a piece of their company for the long-term. If you want a broad base of employee shareholders, you may be better off with Employee Share Ownership Plans (ESOPs). But maybe we are asking too much from just one tool to motivate employees. Right now, we should accept the fact that the stock market is functioning as it should by rewarding companies who correctly account for their stock options. Now that we know how we should count options, we can get started figuring out how to best apply them. Jim Helik is co-author of ‘Energy Markets Risk Management,’a textbook published by the Canadian Securities Institute. He also teaches at the School of Business, Ryerson University in Toronto. |
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