Proponents of stock- and option-based compensation argue that it provides employees with incentives to act in shareholders" best interests. During the bull market of the 1990"s, however, opponents of option-based compensation argued that stock options provide rewards for general market movements as opposed to employee-specific performance. With recent stock-price declines, many employees now hold out-of-the-money or underwater options. In order to retain and motivate employees, some corporations have responded by repricing or replacing underwater options with new grants. This replenishment, however, has become a focal point for shareholder concern with the perception that it rewards employees for failed performance. The corollary is that repricing undermines the rationale for using options as incentive compensation in the first place. The paper discusses the potential benefits of stock options, the accounting for stock options, and other disclosure issues. The primary focus is on (1) measuring the "cost" of option-based compensation, (2) shareholder concerns about the use of stock options, and (3) management actions in the context of underwater options. Emphasis is placed on shareholder voting, how managers manage the voting process, and how in some cases companies take advantage of exchange and market rules to adopt option plans without shareholder approval. The paper poses several questions for further consideration:
- Do exchange and market rules permitting companies to avoid shareholder approval of stock option plans disenfranchise shareholders?
- What types of companies may benefit from option-based compensation?
- What types of employees should receive option-based compensation?
Shareholder concerns over dilution, repricing, non-approved plans, and the overall efficacy of stock options as a form of compensation suggest that this will continue to be a hot-button corporate governance issue.
