Executive Stock Option Programs
THE BEHAVIOR OF CEOS, FIRMS, AND INVESTORS
Perhaps the attack made by the managerial power hypothesis that resonates most forcefully with the public is the claim that CEO pay bears little relation to performance. After all, Bebchuk and Fried titled their book Pay Without Performance: The Unfulfilled Promise of Executive Compensation.1 If we think of the various elements of a typical CEO’s pay package—salary, annual bonus, pension holdings, restricted stock, ESOs, and long-term incentive plans— some of these elements vary directly with the fortunes of the firm’s stock, while others do not. CEO salaries do not tend to fluctuate greatly year to year; this is similar to most salaries throughout the economy. Firms often link the CEO’s annual bonus to accounting results, and it is quite possible for a firm to have good accounting results in a year of poor stock market performance. As a consequence, what the CEO realizes from a long-term incentive plan may not be well-aligned with the stock market results of her firm in a given year. In addition, the value of the CEO’s pension promise is also relatively invariant with the firm’s results. Sometimes total annual payments to the CEO may not be linked to the firm’s current stock market performance—sometimes payments come due according to the terms of the plan even if the firm’s shares are performing poorly.
Thus, it would seem that the major elements of the CEO pay package that are most likely to vary with the current year’s stock market results are the value of the CEO’s restricted stock and ESO holdings. The link between pay and stock market performance for these elements is somewhat difficult to measure. Obviously, the value of ESOs and restricted stock strongly vary with even day-to-day stock price movements. However, cash receipts by the CEO may not be so directly linked to contemporaneous stock price movements. If a CEO sells formerly restricted stock or exercises vested ESOs when the stock market is down, her receipts from these two sources may be high exactly when the stock market is performing poorly.2