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© Copyright 2000 Rogers Media. The following article first appeared in the May 2001 edition of
BENEFITS CANADA magazine.
A better option
Ontario Teachers' Pension Plan wants current stock option plans scrapped. At the very least, these
plans should follow good governance principles.
By Claude Lamoureux
In the last few years, the ontario teachers' Pension Plan has voted against stock options plans. Teachers'
standards for these plans state that dilution should not exceed 5% to 10%; options should not be distributed at
a rate of more than 1% to 2% per year, and; options should, preferably, vest based on performance targets.
Given that Teachers' has lost this battle over 70% of the time, are these standards reasonable?
Let's look at that question by assuming that you are the owner of 100% of a business. How much of your
company would you share with management to produce superior results?
Assume that an annual option grant translates into 1% of the value of the corporation. After 25 years,
management would own a quarter of the business if they have not sold their converted options. Is this a
sound strategy for protecting the value of a company?
GROWING CONCERN
In 1990, the typical large cap U.S. company granted 1.2% of its outstanding shares in options. Today, the
average accumulated overhang for Standard & Poor's 500 composite index is nearly 13%--double the
percentage of 1990. This means the financial effect of options on shareholders is greater than ever.
Another study of over 2,300 U.S. corporations states that 26% of organizations surveyed have a transfer of
value from shareholders to management of over 20%--up from 13% in 1997.
Last August, the shares of a large telecommunications firm were down 48% from their peak of $80 at the end
of 1999. The company granted special options at $42 to employees who already had options costing as high as
$58. The stock continued to fall. With the stock at $16, the company awarded another batch of options at
that price in December. In March, the company awarded its 40,000 employees an additional option at $12.14
for every two they already held.
A spokesperson for the company stated that this gave employees a stake in the company's success. But no one
spoke about the impact on shareholders.
Yes, boards of directors need to motivate management and employees. But have they considered that options
contribute to poor accounting to boost share prices, and frequent repricing? And that option plans rarely,
if ever, align management and shareholders, while they are often at odds with employee results at the
divisional level?
BETTER GOVERNANCE
Here are some modest governance proposals for stock options that help to align the interests of
shareholders and management:
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Advocate alternatives to stock options.
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If stock options must be used, tie the vesting of options to performance criteria.
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Award options only to managers with overall responsibility since the value of options is tied to
overall performance.
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Advocate better accounting for stock options to clearly divulge dilution, and inform shareholders of
the effect of stock options on the net earnings per share.
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Require management to demonstrate how shareholders benefit from share buy-backs needed to pay for
options.
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Lobby the government for tax neutrality for different kinds of incentives, and to amend legislation
that restricts shareholders from discussing common issues and acting collectively.
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Pay directors largely in company shares, which cannot be sold during their term in office.
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Be open to meeting with shareholders to better understand their interests and concerns.
What you do as an investor and as a board member can have a lasting impact on a corporation. Modest
improvements in current compensation practices and in the governance of corporations can have an enormous
impact on individual wealth and, more importantly, on the wealth of all Canadians through their pension
plans. Canadians deserve no less.
Claude Lamoureux is president and chief executive officer with the Ontario Teachers' Pension Plan Board in
Toronto. communications@otpp.com.
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