Heskett Column - How Will We Respond to the "Moment of Truth" in Option Plans? Readers Respond

The "fatal flaw" of giving stock options to the top company managers is that these managers focus on short-term profitability at the expense of the long-term stability of the organization.

The only people who win with stock options are the top managers who cash them in or leave the organization. The middle managers that are there for the "long haul" lose more if the company is not viable due to short-term stock manipulation.

To remedy this, more emphasis needs to be placed on long-term profitability and less on short-term stock prices. Delay payment of any option until five years after a recipient leaves the company or fully retires.

The debate over stock options and the questions raised by Professor Heskett ignore the alternative of rewarding management in cash-rich companies with performance bonuses paid in cash. The attraction of stock options is that they provide a way to hide the cash obtained by executives while at the same time boosting reported profits. Cash bonuses eliminate the problem of valuing options or misleading investors. They can also be more simply tied to other indicators of executive performance than stock prices.

For example, the size of a cash bonus could be reduced to the extent that the company had to use an executive search firm to replace an executive. The ability of an executive to develop a management team to sustain and grow a business after his or her retirement might well be a more important indicator of executive performance than share price. Sustainability of the business would align the interest of management with long-term investments like pension plans.

However, long-term investors are unlikely to be involved in cash-poor start-up companies where stock options can provide a valuable way to align key personnel to the development and survival of the business.

One of the problems with stock options is how they are used as a compensation mechanism directly tied to shareholder value improvement. In the last few years our society has lost sight of stakeholders (vs. shareholders) and ignored the need to have satisfied customers, employees, and other parties to make a company truly successful. As long as stock options are so directly linked to company valuation alone (i.e. unidimensional) the system might be open to inevitable abuse.