How Stock Options Reward Managers for Destroying Value and What To Do About It
Michael C. Jensen
Social Science Electronic Publishing (SSEP), Inc.; Harvard Business School; National Bureau of Economic Research (NBER); European Corporate Governance Institute (ECGI)
Harvard NOM Working Paper No. 04-27
I have long supported increased managerial holdings of equity to reduce the conflicts of interest between stockholders and their agent managers. Yet I recommend that a company never again issue another typical standard executive stock option. The vast increase in the use of options in managerial compensation plans in the last decade does not suffice to identify managers' interests with those of their stockholders and with that of society. My purpose here is to call attention to the fact that typical executive stock options are not structured properly and as a result reward managers for taking actions that destroy value. I also outline how the cost of capital adjusted options first suggested by Stewart (1990) can resolve these problems and recommend that newly awarded executive stock options be structured this way.
Number of Pages in PDF File: 11
Keywords: Performance Measurement, compensation, rewards, value destruction
Date posted: March 3, 2005