The Way I See It… by Michael C. Volker
Unjust
rewards: The case against Stock Options
Let's abolish stock options. I used to be a big fan of stock
options but now I believe that there are better alternatives for boards to
consider.
The original idea behind options was to use them both as a
performance incentive and as a proxy for stock ownership. They allow new
employees to participate in the equity growth of their companies - just like
the founders and investors. It’s
problematic, for tax and regulatory reasons, to simply give shares to new
executives when they’re recruited. That’s why options are popular.
What’s gone wrong? Excessive options grants are the main
culprit. They’ve been regarded as a panacea to the recruiting problem. It's not
unusual for a CEO or VP to be granted the right to dilute shareholders by 5% by
exercising options. For tech companies, share options can approach 30% of a
firm’s issued shares. For public companies, this has led to a steady, annual
dilution in the 10% range.
As long as share prices keep climbing,
shareholders have not been too concerned and companies have been able to bonus
their executives without impacting their bottom line.
But now, companies are being pressured into expensing options. In up markets,
executives become too distracted by watching share prices and in down markets,
out-of-the-money options can demoralize employees. And re-pricing them is very
offensive to shareholders whose "brave money" carries the can.
Abuse is a gentle word for what’s happened. Greedy
executives have made millions on under-performing
companies. How can one possibly justify a $245.9 million bonus to JDS
Uniphase's former CEO? What kind of risk or pain did he endure to deserve
such a reward? Even secretaries and geeks with their hats on backwards made
millions on stock options. Interestingly, and to their credit, Bill Gates and
Steve Ballmer of Microsoft have not granted themselves any options.
Options allow people to participate in stock price
appreciation but without taking any risk. Why should anyone get something for
nothing? And just how much is appropriate? What's a fair allocation for a stock
options pool and how should options in the pool be divvied up among all the
optionees? What's fair and reasonable?
The former Vancouver Stock Exchange (VSE), which was
affectionately referred to as the "Scam Capital" of the world by our
American friends, had the wisdom to limit its junior listed companies to a
maximum of only 10%! The VSE’s successor, the TSX Venture Exchange, has relaxed
this limit as a result of both corporate pressure to do so and the fact that
there are higher limits on other stock exchanges. Exchanges have tended to give
company Boards more discretion in this matter. And that’s the way it should be.
I’ll be the last one calling for more rules and regulations. This is a matter
of of prudent corporate governance – balancing shareholder interests against
those of management.
Contrary to the original idea of encouraging ownership, the
tax treatment of options forces one to sell stock in order to be able to cover
the tax liability and to lock in the gain rather than have a subsequent loss
that cannot be offset against normal income.
Here in
The alternative to options - and one that I suggest could
replace options altogether - is a form of stock ownership plan whereby
employees actually buy stock in their company and thus become real shareholders
- just like you and me. Companies could subsidize such a program and/or make
low interest loans available to employees in order to do this. The main
advantage is that tax complications (you get real capital gains treatment) are
avoided and the question of "how many" shares should be acquired is
determined largely by the employee/investor as opposed to some lofty six figure
options grant.
The
way I see it, options are a good idea turned bad.
Let's get back to basics - taking real risks with real money for real gains!
Michael Volker
is a high technology entrepreneur and director of