Arnold Kling

Executive Stock Options

Arnold Kling, Great Questions of Economics
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Is it in the interest of shareholders to see executives compensated with stock options? 'Jane Galt' examines the pros and cons

Stock-based compensation is meant to align the interests of the managers with those of the shareholders, by making a substantial portion of their compensation dependent on the share price...

Which brings us to the real problem: the risk-reward pattern of stock options is not identical to that of shares.

She argues that compared with outright grants of stock, stock options create a bias toward taking risks. She suggests that options are favored by tax and accounting considerations.

She is in favor of one of the most controversial reforms for stock options, which is treating them as an expense in corporate income statements. The more that Silicon Valley executives and others oppose this, the more inclined I am to view it as essential. If, as the executives argue, proper accounting would lead to the end of stock options as we know them, then they should be ended.

Discussion Question As 'Jane Galt' points out, there are other compensation techniques for aligning shareholder and management interests. What type of system would best deal with the issues of short-term vs. long-term, risk vs. reward, and luck vs. skill?

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