Stock Options Payment of Stratospheric Term Paper

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[. . .] The vice versa in the pricing of the stocks result in 'under water' and render the objective futile particularly at a moment when the substitute employers offer new grant of more valuable options. It is a general consensus that the stock options provide retention incentives but the efficacy with which it operates is under question. They may be several other alternative compensation mechanisms ensuring employees stay with the company.

The deferred compensation or pensions or by progressively increasing the payment with their increasing stay are several such alternatives. In case of the risk-averse employees cash is more valuable than the stock options these alternatives are more effective in terms of the retention incentives and also cost effective. Moreover, there are no justifications for optimally varying the retention incentives with variation in the company stock prices. This leads the workers finding it advantageous of staying with the company in a Bull market and to shift to another employer in an environment of bear market. Firms try to overcome this stage of underwater options by altering the compensations the executives so as to make them find it worthwhile to stay with the company forgoing the offerings of alternative companies. However, it has its own disadvantages as it gives an impression of rewarding poor performance. [Sink or Swim: Firms' Responses to Underwater Options before and after the Accounting Change for Stock Option Reprising]

The next objective behind the stock options is to ensure motivational incentive that tie up the top-executives motivating for increasing performance of the company stock. However, it has its own limitations. It is generally seen that about 90% of stock options are granted to the low level employees and therefore, its efficacy in imbibing motivation for improved performance is still under confusion. It is argued that only an insignificant portion of the total outstanding shares are held by the employees. Thus the problem arises as to what will be the share of the gain that goes to the employees even if they increase the value of the firm. This negligible share of the employees on the total gain coupled with the enormous risk that is imposed upon the employees through stock-based pay create every possibility of making the motivational incentive of the employees futile.

Against this the cash based incentive plans seems to provide more efficient pay-performance incentives which is based on objective and subjective performance measures. It is often said that relating the pay with company stock price provides indirectly incentive to the employees for communicating corporate objective of maximizing the wealth of shareholders, increasing morale of the employee, mutual monitoring encouragements etc. However, examples are there for the boomerang of these benefits especially in an environment of bear market. The decreasing stock prices affect adversely the morale of the option holders. [Compensating Employees below the Executive Ranks: A Comparison of Options, Restricted Stock, and Cash]

To summarize in stock option compensating package, the Corporate Executives find an incentive to increase the systematic risk of their stocks to enhance their own wealth. It is found that the risk incentive seems to be stronger with the lowering of the total risk level. The true option value is underestimated by the Black-Scholes formula due to the inability to incorporate systematic risk into pricing, and conversely the true option is overestimated because of the failure in proper accounting return dependency in computing the constant volatile estimate. Thus Stock Options have several disadvantages and cannot fulfill the objective of company to ensure retention, mobility and attracting the efficient employees and corporate executives thereby ensuring growth and improvement of the company it self. This tends to search for other alternatives in the line of compensating. [Executive Stock Options and Incentive Effects due to Systematic Risk]

As is seen earlier the rationale behind the stock options is expectation of companies on corporate executives to align the interests of management with those of shareholders. The trends in the Bull market of the 1990s revealed its loophole of rewarding the top executives with huge amounts of cash from the exercise of stocks even in most of the low performing companies. This necessitated prevalence of performance-based options in order to provide incentives to the executives for outperforming the rival of the company and the market instead of simply rewarded due to a rise in the share price as is in the case of fixed stock options. [Performance-Based Stock Option Proposals]

Many such performance-based options are advocated which includes-- Premium-Based Options, indicating the exercise prices above the fair market value on grant date by the value of the premium ranging from 25 to 100% of the market prices; Performance-Vested Options where in the options are vested in pursuance of certain pre-determined goals in terms of growth in revenue, profits or return; Price Vested Options which are conferred by the reaching of share prices to a designated level; Performance accelerated options, refers to those type of options where the vesting accelerates in geometrical progression after meeting a specific determined target; Performance-contingent awards which envisages forfeiture of awards based on stocks unless the objectives of performance parameters are not attained thereby infusing an element of risk. The most common of all the performance-based options are indexed options where in the exercise price is linked to the market or index of the peer group fixed in terms of relative performance. [Performance-Based Stock Option Proposals]

Indexed stock options, seen as the alternative to standard stock options mainly stems from the disadvantages of latter. It was observed that the corporate profit of socialfunds.com rose to 108% during 1990-98 while the pay of corporate executives rose to 481%. To add with the rise in the average workers pay was only 28%. This is sheer injustice. In the words of Beth Young, "We believe it is inappropriate to compensate senior executives for improvements in company performance that are attributable to factors beyond their control. Examples of such factors are a general stock market rise in response to interest rate changes or a rise in the price of all airline stocks because of a drop in fuel prices." [Indexed Stock Options Reward Performance] This led to great discontentment against the faulty compensation package and led to think of the indexed stock options. The Indexed stock options are viewed as a method to put the rewards of executives into perspective by linking that with an index that measures the relative performance of the company.

Conversely, the executives are not compensated under the package of indexed options unless it is observed that the company outperforms a fixed index. It may be a general index or a peer group index. Thus the indexed option is viewed as a promising method of ensuring more effective motivation by linking the executive compensation to performance. In case of indexed options the exercise price is determined by a set of references to the fixed index and not known at the time of grant of options. To exemplify, an increase in the average share price to the tune of 10% as experienced by the index group results in the fixation of exercise price at 10% above the market price as on the date of grant. In this manner the indexed options are viewed as a reward for relative rather than absolute performances. The executives of the company are deprived of the compensation unless the stock of the company reaches the specified index. This criterion makes the options comparatively less valuable in a bull market however, at the simultaneously safeguards the potentiality for compensation even in a bear environment when the stock of the company declines of course less steeply than that of its competitors.

Indexed Stock Options Reward Performance]

The Chairman of Federal Reserve, Alan Greenspan is a great supporter for the indexed options. Simply a rising market in the stock options package ensures the executives boatloads of cash; however, it will end in dismal future when the market gains continue to narrow. By means of indexed options the companies guarantee huge paydays for the real executive superheroes. This led the Robin A. Ferracone, the Chairman of pay consultant SCA consulting to remark that "Indexed Options hold the executive to a higher standard." [Commentary: An Options Plan Your CEO Hates] The Indexed Options are said to be linked with the relative performance contrary to the absolute performance. It is a reward of the relative performance. Its relative importance lies in the fact that with the fall of the market no value return is possible in case of traditional stock options while the indexed option ensures pay offs to the executives if the fall in the underlying stock is comparatively lesser than the market.

Even the falling stocks is considered from the point-of-view that it will insure the executives and reward them by not representing the gloomy performance of the company but more positively award them for safeguarding the performances of the company relatively higher in comparison to the performances of the peer companies. So long as… [END OF PREVIEW]

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Stock Options Payment of Stratospheric.  (2004, May 12).  Retrieved February 18, 2019, from https://www.essaytown.com/subjects/paper/stock-options-payment-stratospheric/9473246

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"Stock Options Payment of Stratospheric."  Essaytown.com.  May 12, 2004.  Accessed February 18, 2019.
https://www.essaytown.com/subjects/paper/stock-options-payment-stratospheric/9473246.