Question

Stock options are a popular way for large, publicly held companies to compensate managers and executives. Frequently, the value of stock options granted to executives can result in millions of dollars of additional compensation to executives already earning high six and seven figure salaries. Why do companies favor stock options to compensate executives? Do you see any potential problems with such a compensation program? Explain. Do you think that there should be limits on such compensation? Why or why not?

Answer 1

The reasons why companies’ favor stock options are that stock compensation effectively serves as salary buffers and this keeps the workers and key employees from leaving the company when the level of compensation rises in the market. In some cases stock options can also serve as motivators for employees.

Potential problems with such a compensation program are that for a company the cost of stock options is often higher than the value that a risk-averse employee places on his/her options. This makes stock options, in majority of cases, an inefficient means of attracting, retaining and motivating employees.

Yes, there should be limits on such compensation simply because a company cannot keep on paying in an efficient manner and in a costly manner to its employees. Secondly in majority of cases only top executives are in a position to boost the stock and so paying options in lieu of cash compensation will not be very efficient in the long run. The large majority of employees in the lower level that are given stock options will have only a minor and negligible impact on the stock price.