Winning the options lottery
With the stock market now back near June 2008 highs, you might be patting yourself on the back for having the courage to hang on through the panic-driven lows of late 2008 and early 2009.
If so, nice work. But you likely didn't do as well as CEOs. During those dog days, a lot of chief executives got a special treat from their boards: mega-grants of stock options with exercise prices at bargain-basement levels.
Most of their stocks have bounced back, often simply carried along by the economy and the market. So they've made out like bandits. The biggest winner in this market meltdown mega-grant lotto is Sirius XM Radio (SIRI.O) CEO Mel Karmazin. His take so far: $200 million, according to Equilar, an executive compensation data firm.
You won't read much about these winnings, because they are buried in company paperwork. But today we'll take a look at six of the biggest mega-grant lotto winners. How much are they up? Just these six big winners — including Howard Schultz of Starbucks (SBUX.O) and Alan Mulally of Ford Motor (F.N) — are up a combined $477 million, so far.
So how does this happen? Companies like to hit target pay levels each year, and a big component of pay is always options, explains Paul Hodgson, a CEO pay expert with GMI, an independent corporate governance research firm. And typically, companies use the current stock price as the reference point.
So when stocks decline, as they did during the panic, boards grant a lot more options to hit the same level of pay. This means CEOs can make a killing when the market recovers, without doing anything special to earn it.
Most CEOs didn't have to hit performance targets to cash out these mega-grants. The options grants also come at a huge cost to shareholders; when the CEOs exercise these options, companies have to issue new shares, which dilutes earnings. Or else they have to buy back stock to offset the dilution, which eats into cash flow. "It makes no sense, other than the fact that so many of our public companies' primary purpose is to enrich insiders beyond the realm of avarice," says Albert Meyer, who considers pay levels when deciding how to invest at a fund he manages, Mirzam Capital Appreciation (MIRZX).
Outsized stock-option grants can also raise the potential for executives to take excessive risks, according to pay experts at ISS Proxy Advisory Services, which advises professional investors on how to vote at annual meetings.
One fix would be "premium pricing," which means CEOs make money on options only if their stocks go up more than the market does, says Hodgson. Another fix might be to limit gains on options granted during panics, so the CEOs could make only a set amount on them, says Anne Sheehan, the director of corporate governance at California State Teachers' Retirement System.
That would be good for shareholders. But would CEOs and corporate boards accept limits on bonanzas like these? Too often, company boards are more worried about CEOs than they are about shareholders, one of the reasons you sees mega-grant giveaways like the examples on the next six slides.
* All dollar amounts in USD.
* Bing: What are stock options?
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