Stock options have been a staple of executive compensation for decades. Since their introduction in the 1950’s, their use has increased on an ongoing basis. Today, over 90% of executives receive stock options as an integral component of their earnings.
To ensure clarity, let me quickly define what is meant by this term. Stock options are granted to key individuals in a corporation on a specific date. Usually there is a vesting period of 1-5 years before they can be exercised. It allows the individual to purchase company stock at the price it was on the day the options were granted and then resell them at a future date when the stock price has increased. Essentially, it is a risk-free method of stock ownership because the individual does not have to pay anything upfront and can choose when to buy and then sell at a time that is most suitable to them. Because of favourable tax treatment, this form of compensation is highly desirable.
Options are different from being awarded stock before a company becomes public. The most famous example is that of Steve Ballmer. Ballmer was a friend of Bill Gates of MicroSoft fame. Gates and his partner Paul Allen knew that they needed and executive to run the company and they enticed Ballmer to quit graduate school to join them. In return, Ballmer received a salary of $50k and 4% ownership of the company. Ballmer's shares are valued in excess of $120 billion now.
Options such as those I have described above are also different from those typically granted in startup companies, frequently in the tech sector. These options are used to attract key employees and are essentially awarded in lieu of direct compensation. They are valueless until the company goes public at which time they may be exercised in full. For the fortunate at places like MicroSoft, Google and others, many became overnight millionaires on the day the company IPO was initiated.
My focus here is to look at the impact of stock options being granted in existing mature companies and how these options have corroded the integrity of so many in the executive ranks. When millions of dollars are on the line, how are otherwise reputable individuals seduced into making self-serving and often destructive decisions with regards to how the company is run and to whose benefit decisions are made. At a time when integrity is at risk in so many areas of our society, what role are stock options playing. Let me examine several examples over the past 25-30 years as evidence that we have a problem.
Eckhard Pfeiffer
Pfeiffer was the CEO at Compaq computers from 1991 until his ouster in 1998. His arrogance and unwillingness to address the issues that developed under his leadership led to conflict with the board of directors. While not specifically an issue of integrity, his insular management style compromised his decision-making abilities and drove Compaq to the point where it was acquired by HP in 2002.
At the time of his departure, Pfeiffer was allowed to exercise $70 million of his stock options in addition to his $6 million severance. I assume that made the landing a little softer.
Bernard Ebbers
Ebbers was the CEO at WorldCom, a telecommunications giant up to 2002. Ebbers held substantial WorldCom stock accumulated over years but he had engaged in fraudulent accounting practices to maintain the stock price. The board authorized personal loans in excess of $400 million to Ebbers in lieu of him selling his stock which could have caused significant damage to the stock value. All this was to no avail as the fraud was uncovered, WorldCom declared bankruptcy, and Ebbers was convicted in 2005 of his crimes and was jailed for up to 25 years. He died in 2015, shortly after his parole on compassionate grounds.
Dennis Kozlowski
Kozlowski was CEO at ADT Inc., the world’s largest electronic security company. Between 1997 and 2002, Kozlowski was paid over $500 million in a variety of ways including stock options. During this time, he also colluded with the company CFO to disguise a series of corrupt actions including the company payment of over $1 million to finance a birthday party for his wife. In 2005 he was convicted of his crimes and sentenced to up to 25 years in jail. He continued to proclaim his innocence until 2013 after which he was paroled. He forfeited his earnings and possessions totaling almost $200 million.
John Roth
As a career employee at Nortel, Roth became CEO in 1997 until his termination in November 2001. Under his leadership, Nortel pursued a growth strategy through acquisition which helped to meet financial targets but severely burdened the company with debt. By 2008, the company was bankrupt leaving thousands of employees in jeopardy for their pensions and prompting some of Roth’s successors to be criminally charged, and subsequently found innocent. Roth escaped with over $100 million in stock option profits, largely on the basis of his reckless spending which fed his options performance. When challenged about the money he made in those CEO years, Roth’s response was essentially ‘...nothing to see here...’
Other “All Star Failures”
Ken Lay of Enron cheated until Enron went bankrupt in 2001 and he was convicted in 2006. He made $220 million on stock options.
John Stumpf of Well Fargo was CEO starting in 2007. He allowed unethical sales tactics to take place and was grilled before the US Congress and eventually accepted a lifetime ban from banking in 2020. I suspect that would give him enough time to spend the $130 million in compensation that accrued to him upon his resignation.
Dave Calhoun of Boeing is earning about $33 million this year for failing to properly address quality issues at the company. He is leaving at the end of 2024 ‘voluntarily’ in order to accept another package worth $45 million in stock options.
But apparently Boeing is has failed to learn their lesson. Calhoun’s predecessor, Dennis Muilenburg, also seems to have put profits over safety. His resignation in December 2019 was eased by his over $60 million in stock options.
Others still at the trough!
Mary Barra
Barra is CEO of General Motors. You remember GM! They are the auto giant that the US government bailed out in late 2008. She was not CEO at the time but she was an integral part of the senior management team. In an interview in September 2023, Barra defended her $30+ million compensation which was comprised principally on stock performance. She chose not to defend her 34% salary increases over the prior 4 years while defending the company’s offer of 20% to its striking UAW workers. I guess that it is hard to defend the indefensible.
The Unnamed Crowd
As I mentioned above, stock options are granted on a specific date and their base value is established on the basis of that date. However, there are hundreds of examples where corporate executives sought to ‘enhance’ their value by back dating the award date to a point in the past when the stock was valued significantly lower. Depending upon the number of shares to which an individual was entitled, these changes could amount to an increase in value of hundreds to millions of dollars. The list of successful prosecutions is extensive and resulted in both fines and repayments all the way to incarceration.
Mr. Piggy, Elon Musk
Musk redefined the meaning of stock options. Currently before the courts in Delaware, Musk is seeking to get final court approval of a compensation package already approved by his Board and the shareholders. Wait for it...Musk wants the court to rubber stamp his $56 billion, yes BILLION, package of stock options. I cannot even begin to comprehend how they came up with that number. It’s like someone suggested that he receive a billion for every year that he has lived, plus interest for the delay in getting it approved. It is unbelievable, unimaginable, incomprehensible, unnecessary and... vulgar!
The argument for stock options is that they help to ‘align performance objectives with shareholder value’. On that one I call bullshit! If you cannot get an executive to align performance objectives based on their multi-million-dollar salary, I think you have the wrong person. If you think that the recipient of these perks is a unicorn, then explain to me why there was another unicorn to replace all of the discredited ones in this essay. Pick your very best unicorn – Steve Jobs, Bill Gates, Jeff Bezos – and you will find that every one of them has been successfully replaced and that their companies have not only continued but they have flourished.
Why is this an issue? Simply this. According to the Economic Policy Institute, executive pay has increased over the years from 1978 to 2020 by a staggering 1,322%. Back in the day, executive compensation was 42 times higher than the average wage of the rest of the employee base. By 2020 it had risen to 351 times. Certainly, base salaries had increased. But the impact of stock options which are generally offered only to a select few has been the driving force of this inequity. And there is no evidence that it generates better corporate performance.
In concert with this gross disparity, it is necessary to recognize a parallel change in tax treatment. When first introduced, stock options were taxed at a person’s nominal tax rate. In the US in the mid 1970’s, the top marginal tax rate was 70%. Lobbyists managed to have stock options the same as capital gains, at 25%. In the 1980’s the marginal tax rate was reduced, first to 50% and then to 28%,
So, while gross personal income in the elite levels increased at the exorbitant rates noted above, after tax pay was actually being multiplied by an additional 200%.
Is it really any wonder that the integrity of the individual has been seduced to maximize personal wealth for the select few?
We are caught in a vicious cycle. The Board of Directors of Company A wants a high-powered individual to be the face of the company and to drive shareholder value. They indicate to a search firm that they intend to pay in the top quartile of their industry peers to ensure that they attract the interest of only the top performers. The search firm identifies candidates and recommends compensation models that reflect the ‘market’ for these people. Once a candidate is placed, the whole of the quartile is lifted up. So, when company B makes a similar request, the asking price has already gone up. The search company has a vested interest in maximizing the compensation package because they are paid a commission on the total. More to the candidate means more to the search company.
Companies need to break the pattern. A lack of integrity in the hiring process will ultimately lead to a lack of integrity in performance. The examples that I have noted are only the most egregious. It would be naive to think that they are not simply the tip of the iceberg.
Let me close with an example of integrity. Ed Clark served as the CEO of TD Bank from 2000-2014. During this period TD grew to be one of the leading financial institutions in North America and one of the few which was not impacted severely by the 2008 recession. In 2009 he refused a $3 million bonus because the company had struggled and he felt that he should carry some of the pain. When his earnings approached $10 million per year, he established a trust fund to direct significant amounts to charitable causes. Upon retirement he was awarded a lifetime pension of $2.5 million per year. Clearly, that is a handsome sum but it is far less than the obscene amounts granted to others listed previously. He led as he lives, with purpose and integrity and a view to the welfare of others. His servant attitude left a legacy of decency that demonstrated that success does not have to come at the expense of others.
Dignity is success in and of itself. Companies must strive to see these attitudes return to the Board Rooms and Corner Offices across North America.
Start by limiting stock options!
