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Thursday, July 18, 2002

Just a thought...

Everyone is aware by now, unless you view the news with blinders, that corporations far and wide are being scrutinized for inflating their revenues, and earnings reports. Is it any wonder that this has happened? Consider that most CEOs for American corporations are paid primarily with stock options. First of all, let's define a stock option. Usually on an annual basis, companies issue a structured number of options which have a specific life (usually ten years) and can be vested (or cashed in) in increments of 10-25%. The idea is that CEOs can cash these options in as prices rise, and purchase stock for the original discounted price, or they can make a profit by taking the difference in the new price and the old. Supposedly, the motivation exists for the CEO to contribute as much as possible to maximizing the value of the stock because of their short duration. They seem to be a very fair, reasonable way to reward CEOs for their performance, without burdening the company with excessive salaries. Right?

Not so fast.

The problem with compensating CEOs through options is that they will stop at nothing to make sure that stock price is lofty, even if it is artificially so. Human nature dictates that one would want to sell off stock and maximize profit from doing so before the price fell to its "true" levels. This is the primary reason that CEOs have pursued the "off the books" deals, such as what Enron did and AOL is being accused of recently, which have overvalued the company's profitability. There are other issues with payment with options as well, such as inflated salaries (does anyone doubt that some CEOs are overpaid in options because they don't count against the company's bottom line?), and a weakening of the relative strength of non-optioned shares of stock (called "dilution" by Wall-Street types).

After the fall out from the latest corporate meltdowns have dissipated, I hope that publicly-held firms will consider the travesty of such maneuvers as paying management with options. In theory, options are good. In practice, they spawn misrepresentation, manipulation, and outright lying, for the sole purpose of a temporary overvaluation of a share. Direct, monetary compensation would create a measure of affordability and viability. If the company under the CEO's watch was underperforming, the shareholders, by proxy, could either cut his salary, or terminate him altogether. Accounting practices would be cleaned up significantly, as options are an accounting mess. Shares outstanding would more easily maintain their value. And Enron debacles would be avoided.


.: posted by Dave 3:16 PM

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