Stock Options an Incentive? Results Say No

In a finding likely to make waves in the world of executive compensation, a new study by a pair of UC Irvine researchers concluded that stock option awards have no impact on corporate performance.

Stock options, of course, have become the high-tech industry’s favored method of attracting, retaining and rewarding talented professionals. Common wisdom has it that in today’s competitive job market, executives require such incentives. Once on board, they’ll show better results if they have a vested interest in seeing the company do well, the thinking goes.

Trouble is, that just ain’t so, according to professor of finance Eli Talmor and James Wallace, an assistant professor of accounting. They studied executive pay at 108 computer firms and compared it with pay at companies in the manufacturing and service sectors. While a link was found between cash compensation--salaries and bonuses--and company performance, there was no such relationship between stock options and a firm’s financial and shareholder returns.

The difference could be partially explained by the fact that most cash bonuses are for past performance, while stock options are used more as incentives, Wallace said. But it would then be logical to expect stock options to lead to improved financial performance in the future. “Unfortunately, we didn’t find that either,” he said. “It seems that options are given out with no apparent logic.”

Wallace said some executives have pointed out that the study only looked at how companies were doing one year after awarding the stock options, and that more time is needed to measure their effectiveness. Perhaps, he said. But he wondered why many executives frequently sold blocks of stock after receiving their options, thus lessening their stakes in the companies and sometimes contributing to a lower stock price.

The study undercut one other widely held belief, that high-tech companies have less cash than other businesses, which is another rationale for issuing stock options rather than cash awards. But the researchers found that computer companies actually have a relatively high level of cash on hand.

Wallace noted that, given the stock market’s recent slide, the debate over stock options may soon be moot, as companies find it increasingly difficult to use their shares as currency. If a bear market is here, he said, the stock option fad may soon fade.