In the recent past, the subject of share options has rarely been out of the news - in the business pages, anyway. Initially, of course, the controversy was about the accounting treatment but more recently, interest has centred around the highly suspect practice of re-pricing share options that have already been granted.
When I mentioned this to a colleague who works for one of the UK's most respected companies, he expressed some surprise that this had not become a bigger issue already. He went on to tell me that, in his company, there had been considerable pressure from the management cadre to do exactly the same.
This set me thinking again about the wider issue of executive share options and how they are supposed to motivate top management by aligning their interests with those of the shareholders. The more I pondered, the more convinced I became that the basis of this argument is fundamentally flawed and that options as currently structured not only do not do this properly, but can, and often do, act against the interests of shareholders.PREVENTING CONFLICT
The theory, of course, is that by giving senior management the opportunity to share in the increased value of the company they work for, they will act in a way that is more likely to bring about such an increase. This is based on the well-rehearsed argument that, in the absence of such incentives, the principal objectives of management will be to preserve their jobs and their perks at the expense of the shareholders. Consequently, a mechanism needs to be put in place to prevent this conflict of interest and thus far, I fully agree.
My concern, however, is that share options do not do this because they actually cause the management's objectives to diverge from those of the shareholders. This is because, firstly, an option is a one-way bet, whereas for the shareholders it is two-way - they can lose some or all of their investment if the company does not prosper. Thus, the executives do not suffer in the same way from a decline in the company, but happily join in any success.
Additionally, in most share options schemes, the potential gain from the options represent a material proportion of the overall remuneration of the executives concerned due to both the gearing effect of options and, usually, the deliberate design of the scheme. Again, this is markedly different from the potential gain to the shareholders that would result from the same increase in the share price because their gain is ungeared and, most probably, represents only one part of a diversified portfolio.
Moreover, the interests of the executives may well be much more short-term than those of the shareholders. They are likely to gain the most from a depressed share price, followed by a surge - at which point they exercise their options and exit - followed by another slump, which allows them to receive a further grant of options at the new low price. Clearly, this is not a pattern of share price movement that would satisfy long-term holders of the shares.
And this, so I am told, is exactly how the beneficiaries of executive share option schemes view them. My mole went on to tell me that, in his company, the investor relations manager receives a series of tongue-in-cheek emails just before the date at which the strike price is set each year, urging him to put out news that will depress the share price temporarily.
I am not sure that I believe that, but it is just the sort of thing that gives executive share options a bad reputation - which, however, I now consider that they thoroughly deserve.
Mike Brooks is a freelance business writer and consultant; he can be contacted at.