Skin in the game.

• Position: Brief Article

AS CHAIRMAN of the compensation committees of several public companies, I have laddled out gobs of stock options in the belief that these grants link the interests of management with those of shareholders. Over the years I have come to appreciate that option holding and shareholding are very different in terms of the degree of "skin in the game.

Retention, competitiveness, and employee ownership are frequently given as the main objectives of stock option plans; however, the latter is not often achieved. As pointed out in a 2001 Watson Wyatt Worldwide study entitled "Stock Option Overhang: Shareholder Boom or Shareholder Burden?," the top five executives at 1500 top U.S. companies owned or held options on 1.25% of their firm's shares in 1992; by 1998 their stock-related holdings had climbed to 3%. Moreover, the dollar value of these shareholdings had soared due to the run-up in the stock market.

However, their direct share ownership percentage had remained constant. In the early '90s, these executives owned slightly more shares than they held in options; by the end of the decade, their option holding was more than twice their shareholding. Option holders had sold the vast majority of their holdings upon exercise, and thus failed to increase their outright share ownership. As a result, over the past decade top management's ownership percentage stayed roughly the same at approximately one-half of one percent. Option programs had not lead to increased employee ownership.

Over the past 10 years, stock option overhang -- the number of stock options outstanding plus those available to be granted as a percentage of a firm's total shares outstanding -- has doubled to an average of 14%...