The Executive Compensation Controversy - Fondazione Rodolfo ...

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THE EXECUTIVE COMPENSATION CONTROVERSY: 24 MAY 2010A TRANSATLANTIC ANALYSISwhereN'(z) = 1 2" e#z 2 / 2 .!The Option Vega is related to the “incentives” executives have to increase the risk (since itindicates how much the value of the option increases for an incremental increase in stockpricevolatility). The Option Vega is maximized when:P = Xe "(ln(1+r)"ln(1+d)"#2/2)T .For typical values of r, d, and σ, the Option Vega is highest when the stock price is close tothe exercise price. For example, note that σ=.30, r=4.6% and d=0. Then!ln(1+r) " ln(1+ d) " # 2 /2 = -.000027and the Option Vega is maximized when P = .99997X.!-53-
THE EXECUTIVE COMPENSATION CONTROVERSY: 24 MAY 2010A TRANSATLANTIC ANALYSIS3. The Transatlantic Pay Divide: Is Europe Catching Up? 643.1. Introduction (and some more history)While executive compensation has sparked outrage in the USA from time to time sincethe 1930s, the European situation was much quieter until the mid-1990s. The differentexperiences on the two continents may in part reflect differences in pay practices: the USApractices might simply be more outrageous. Perhaps more importantly, the different reflectsthat detailed information on individual executive pay practices including stock options havebeen generally available in the USA since the 1930s, while similar information has onlyrecently become widely available in Europe. Indeed, there is a curious circular relationbetween disclosure and outrage: outrage over perceived excesses in executive pay – usuallystemming from a relatively isolated event – fuels demand enhanced disclosure, which in turnyields more opportunities to perceive isolated excesses leading to more even more disclosure.In the UK, the “isolated event” related to the 1990 privatization of government-ownedelectric, gas and water utility companies. Executives in these utilities had received options tobuy shares after at exercise prices initially undervalued by the government, leading towindfall option gains over the next several years. By mid-1992, the Labour Party becameangered that executives in the privatized water industry had options worth over £20 million(about €37 mil in 2008-constant Euros 65 ) at a time when customers were facing higher waterrates. 66 The controversy intensified in early 1995, when it was revealed that over 100executives in electric companies were set to gain in aggregate around £40 million (€63 milin 2008-constant Euros) by cashing in options often ahead of their firms’ initial publicoffering. 67 Several executives even partially avoided taxes on these gains by transferring64 This Section draws (in part) from Fernandes, et al. (2009), Conyon and Murphy (2000), and Conyon andMurphy (2002).65 The historical numbers in this section are calculated somewhat convolutedly by converting into US dollarsat the historical exchange rate, adjusting to 2008-constant dollars using the USA Consumer Price Index, andconverting into Euros using the 2008 year-end exchange rate.66 Ford, “Water chiefs' £20m shares windfall angers Labour,” Times (June 1, 1992), p. T.67 White and Milner, “Anger over utility chiefs' £40m share bonanza,” Guardian (May 15, 1995); Calvert andNelson, “Exposed: the utility chief millionaires,” Observer (May 14, 1995).-54-
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