Stock options as Incentives

Stock options give individuals the right to purchase stock at an agreed-upon price during some future period. The price is independent of the trading price of the stock at the time the option is exercised. For example, a stock option might be given to a CEO that allows the CEO to purchase 1,000 shares at $15 per share at any time during the next five years. If the market price is above $15, the CEO makes a profit by purchasing the 1,000 shares, then selling them; if the market price is below $15, the CEO does not. Since the CEO is primarily responsible for the direction of the company over the five-year period, the incentive is for the CEO to maximize the company's performance in order to increase the stock price. Of course, the trading price of the stock is not directly controlled by the CEO, but stock options are

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least six months after the stock option was originally granted. By exercising the option and immediately selling the shares, executives can realize profits without putting up any cash from their own finances. Typically, however, most executives choose to exercise their options and hold the stock, or defer the exercising of the options to a later date (McMillan & Young, October 1990, p. 37). Either of these strategies, however, runs the risk that the executive will have too great a percentage of company stock in their personal investment portfolios. While potential investors and shareholders consider such a bias favorable, the executive is likely to seek a more balanced portfolio structure. To avoid overweighing their portfolios with company stock, yet to demonstrate to stockholders that they have a personal interest in the company, some executives have worked with compensation committees to create stock-for-stock exercise programs in order to exercise new stock options. Under these programs, the executive uses old shares to exercise new options. In the above example, the CEO may exercise the option of the $15 shares and purchase 1,000 shares of stock. Later, the CEO may be granted a new option at $20 per share (but this ti
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Approximate Pages = 9 (250 words per page)

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