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• W332095628 abstract "Compensation plans linking the pay of managers to the share values of their companies can reward or penalize them for events they don't control. A new model is needed. The recent carnage on European and US stock markets has only highlighted the problems of linking managerial compensation to stock market performance. Many employees who were lured to join new firms with the promise of lucrative stock options now find themselves holding worthless paper--while the firms themselves are wondering what they can do to stop employees from leaving in search of greener pastures. Stock options are seen as a way of linking managers' compensation to investor returns. The better a manager performs, the more the stock price will rise and the more the options will be worth. But as many employees of dot-com companies would now attest, stock price movements are a crude measure of how well managers are doing. Short-term share price movements are driven in large measure by the market as a whole or by the industry sector. A statistical analysis of total returns to shareholders (TRS) for almost 400 companies since 1962 suggests that, on average, over 40 percent of the returns during any one- or three-year period can be explained by market and sector movements. (These are the periods over which share price performance is usually measured for the purpose of evaluating managerial performance.) So if managers are being rewarded on the basis of share price movements alone, they are in large part being rewarded (or penalized) for events outside their control. Traditional share option schemes do exactly this, and the bull stock market of the past decade has rewarded option-holding employees in all but the most woefully underperforming enterprises. Exacerbating matters is the fact that share prices are driven in the short term more by differences between actual performance and market expectations than by the level of performance per se. In other words, it is the delivery of surprises that moves prices--for example, failing to meet analysts expectations or exceeding them. As a result, companies that perform well consistently can find it difficult to move their share price. The market may believe that managers are doing an outstanding job, but it has come to expect no less, and its approval is already factored into the share price. In these companies, extraordinary management performance might go unrewarded if compensation were based on stock market performance alone. On the other hand, managers in poorly performing companies might find themselves over-rewarded. This is because stock prices reflect expected future performance. Merely the announcement of a new chief executive officer can be enough to shift a share price by more than 10 percent even before he or she takes the helm--and long before performance has improved. So how should managers' performance be measured and rewarded? Not all companies hand out share options. But many link compensation to stock price movements in other ways. The most common stock market measure is TRS: stock appreciation plus dividends paid. This has the same shortcomings as share options, since it too is a measure of how much managers beat or fail to meet market expectations and is affected by general sector and market movements. …" @default.
• W332095628 created "2016-06-24" @default.
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• W332095628 date "2000-06-22" @default.
• W332095628 modified "2023-09-27" @default.
• W332095628 title "Stock Options Aren't Enough" @default.
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