CEO stock ownership: Goals that make sense.

• Author: REDA, JAMES F.
• Position: Brief Article

Is this happening at your company: Executives exercising their stock option, liquidating their position, and not holding the underlying stock? If so, here is some counsel on setting stock ownership guidelines.

AS WITH THE stock market itself through most of the 1990s, the fundamentals of executive compensation are significantly above historical or logical levels. The increasing levels of compensation over the past five years do not appear to have any basis in the marketplace. It appears that the high levels of executive compensation can be attributed to management's aversion to stock awards set by the Black-Scholes model, which places a higher value on stock at higher price levels. Of 100 top-performing companies we surveyed, about half awarded the same or more stock options from the year prior over the five-year period from 1994 to 1998, even though Standard & Poors' 500 Stock Index increased at the annual rate of approximately 20% over that five-year period.

Results of studies differ with respect to a link between ownership and corporate performance, but it is unproven that a long-term incentive grant with no real downside risk will compel management to work harder or make better decisions. Compensation committees, Wall Street analysts, and university professors agree that there is a competitive level of compensation needed to attract the right executive. Once the executive commits to a position, however, intrinsic qualities such as work ethic, curiosity, and the challenge of meeting goals are far more powerful than stock ownership.

The most startling trend in the past five years is the unusual behavior of boards and senior management in determining stock awards. The fixed share methodology, which works fairly well in a normal environment of 8-10% stock growth, fails miserably when the stock market growth accelerates to 20-25% per year, as it has over the past five years.

Options versus real shares

It does not appear to matter to stock performance whether the executive's economic benefit is held in options or in real shares, except that, because stock option holdings provide greater leverage, they should give the executive more incentive to be concerned about stock price movement. A more efficient approach would be to prohibit exercise of stock option awards unless the executive holds more than the equivalent number of shares in the option spread (on an after-tax basis), thus encouraging executives to hold stock options which will be more...