In two recent NY Times articles the issues of stock option size and timing were brought to the forefront. In numerous cases, large stock option grants were given to certain executives in advance of strong company news. In other cases, executives were given options soon after bad news created 52-week lows. Is it coincidence, walking a fine line or insider trading? It would appear that in both scenarios, executives were trying to time the market. The extent to which management and the board purposefully rigged the timing would probably determine whether a law was broken. Unfortunately, it is difficult to know or prove.
To combat the issue of option timing, we have been advocating the concept of regularly scheduled grants. For example, instead of giving executives large grants whenever the board deems appropriate, a company could initiate a smaller annual grant at a pre-defined time of the year. We have further suggested that the grant could be fixed to the same day of each month and given out on a monthly basis. The theory of “income averaging” is commonplace on Wall Street but executives seem to dislike it when it comes to owning their own stock. The advantages of granting options in this fashion are obvious:
- It dispels the timing issue
- Balances compensation administration
- Handcuffs executives for a longer period of time
- Makes options less susceptible to volatility
- Keeps management from being highly motivated to manipulate stock price
- Vesting and purchase happen over longer period of time and in smaller amounts
- Companies with large option programs would have less overhang issues
- Companies would have less pressure on stock price when insiders sell.
Although compensation administration costs would increase, we believe that the benefits far outweigh the increased costs. Furthermore, we believe public companies need to show as much transparency as possible in making compensation decisions. Compensation committees are being held to a much higher standard and liability has grown along with it. We still deem equity pay to be an important part of compensation administration; we just think it is time to end the compensation free-for-all.