Are Compensatory Stock Options Worth Reforming?

Matthew A. Melone, Are Compensatory Stock Options Worth Reforming?, 38 Gonz. L. Rev. 535 (2003).

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C.E.O. ‘s and their boards should simply reach the conclusion that executive pay is excessive and adjust it to more reasonable and justifiable levels.

Stock options reward the good, the bad and the ugly in a booming market and reward nobody in a bear market….[T]here ought to be an extreme bias in public companies against their use.

Paul A. Volcker, former chairman of the Federal Reserve Board.

The reports of corporate scandals that have filled the newspapers in the past year have embroiled various institutions and practices in controversy.

Boards of directors, senior executives, independent auditors, law firms, stock analysts, and investment and commercial banks have had a lot of explaining to do and litigation to fight. Lately, however, that attention has turned to efforts aimed at reforming stock option practices. Whereas stock options were once seen as the fuel driving the new economy, they are now portrayed as a contributing factor to corporate malfeasance. A seemingly never-ending bull market has the propensity to inhibit challenges to established orthodoxy. The end of the bull market has resulted in hard questions being asked. Unfortunately, they are the wrong questions. Incessant calls for the reform of stock option compensation miss the larger question-are they worth reforming at all? This article asserts that they are not for three broad reasons. First, the incentive-alignment benefits offered by these instruments are not as great as their proponents assert. Second, stock option compensation practices have been co-opted by management and result in rent extraction. Third, stock options contribute to and are symptomatic of a shareholder wealth culture that has had corrosive effects on corporate institutions…Read More

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