Just who was getting those options? (Part 2)

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Corey Rosen of the National Center for Employee Ownership sent me a comment on my options backdating posts that I figure deserves a post of its own. Take it away, Corey:

Justin Fox’s suspicion about backdated options being more common for top executives is backed up by broader data. In a July study of 53 companies that were being investigated for backdating at the time, Jack Ciesielski of the Analyst’s Accounting Observer found that 57% of the companies involved granted considerably more options to their top executives relative to other employees than did companies in general.

The backdating scandal highlights another problem with options. More than anything else, they reward volatility (the formulas used to calculate option costs for accounting statements weight this factor most heavily). It’s better to have an option on a stock that goes up and down sharply than one with more steady growth. That is hardly what we want to reward people for, especially top executives who can make decisions that increase volatility. That’s especially true for today’s CEOs, whose tenure expectations have become measured in just a few years, not the long term. Options still make sense for growth-oriented companies, especially relatively young companies, but they are not always appropriate for more mature companies.

The real problem that seems to be getting scant attention, however, is who gets equity awards. Options and other grants are still highly concentrated among a few top executives because, their compensation consultants advise them, they are the people who really matter. Yet these same executives also say “people are our most important asset” and that “we are a people first company.” Apparently, they mean a few people are their most important asset, and the rest are replaceable parts of no particular consequence.

Yet the most brilliant strategic initiatives from a CEO will fail if the receptionist is rude to customers, the machinist pays little attention to quality, the technician with a better idea of how to fix machines has no reason to share it, or the barista with an idea for a new coffee drink can’t get anyone to listen. Everyone in a company can make a contribution or cause problems, and to argue that they do not merit a stake in the company is short-sighted and self-serving. Companies like Whole Foods, Starbucks, and Southwest Airlines all follow a very different approach by sharing ownership widely. They haven’t been shabby investments over the last 20 years either. Over half the for-profit stock corporations on Fortune‘s 100 Best Companies to Work For share ownership with most or all employees, and, overall, stocks on that list has outperformed the S&P by over 300%.

The data support this. The most comprehensive study ever of these issues was recently completed by Douglas Kruse and Joseph Blasi at Rutgers, who found that the more concentrated equity awards are in a company, the less likely the company will do well in the ensuing three years. (The study has not yet been published.) By contrast, broad-based ownership companies perform much better after they start their programs. This may fly in the face of conventional wisdom that only some people have any meaningful link to corporate performance and stock prices, but the data are robust and significant–and backed by many other studies.

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