The Truth behind Stock Options: The Reasons Why They Don't Work

Résumé du document

This report provides several theories about the dysfunction of stock options and the reasons why they do not work. Our study is focused on the 90's, especially in the USA, a country where stock options are the most generalized. This paper examines the evolution of stock options in three different western countries: USA, United Kingdom and France. Data and studies permit us to illustrate the theories about attraction, retention, motivation, and the hypothesis that perceived cost is lower than economic cost. Although stock options can have inciting effects for some reasons, we explain in this report that stock options do not really work or work only for chairmen or top 5 executives. Nowadays, there is a huge debate about how to provide incentives employees. There are many ways to recruit, keep and motivate employees. One way, is to give workers a contract which includes stock options. Since the early 70s, stock options have become one of the most important derivative instruments besides stock futures.

Extraits

[...] The trends for stock options appear in the early 1990s. The values of options granted by the average firm in the S&P 500 increased from an average of 22 millions by 1992 to 238 million per company by 2000. We can see from the figure 1 that the escalation in options grants was not restricted to CEOs or even to top-level executives. Like we said earlier, it's true that this sort of compensation (stock options) can attract highly motivated and entrepreneurial employees who believe they can increase company stock prices. [...]

[...] It will have a direct effect on the number of stock options allowed. It will have a result that stock options are likely to be reduced and concentrated among those executives and key technical employees who can plausibly affect company stock prices[8]. This way, the weakness of the stock options for lower-level employee will not be as apparent and stock options can become really good options for attract, motivate and retain in the company highly motivated and entrepreneurial employees . [...]

[...] For non-qualified options, the taxation is higher but still, the employee doesn't have as many restrictions (he can vest his options anytime) and the company can deduct the taxation the employee pay for the difference between the exercise price and the stock price. Because of these reasons, usually company use non-qualified options. Like we explained earlier, the accounting rules established by the FASB in the U.S permit companies to not pay taxation for options when they are grant because the spread is zero at this time (the exercise price is the same as the grant-date market price). [...]

[...] We can find too, in UK, another element of salary, a medium term bonus. Finally, we can observe that in UK and in Germany, chairmen's r wages are primarily based on the basic salary. As a significant share of their earnings is indexed on stock options, French chairmen just want to make higher their companies' stock exchange quotation, but their view is limited just to the date on which they can exert their options. Now, there is a question that everybody asks: CEOs want either to grow rich personally or to develop their company. [...]

[...] Second, laws and taxation were more favorable to stock options, these last being considered as an exempt to the deductible salary. These facts permit to develop very quickly and to boost the wages of CEOs and top 5 five executives. Another reason could be the very good health of the American stock exchange. The euphoria of the financial bubble at the end of the 90s has been marked by the attribution of exorbitant income to the quoted companies' CEOs. A great number of firms, before the bursting of the bubble, became highly overvalued, as CEO's, CFO's and directors tried to achieve the bigger percentage of benefits from the value of the company with their options. [...]