The Executive Compensation Controversy - Fondazione Rodolfo ...

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THE EXECUTIVE COMPENSATION CONTROVERSY: 24 MAY 2010A TRANSATLANTIC ANALYSIScommittee made several recommendations regarding option plans applicable to all publiclytraded UK companies:• Executive options should be taxed as ordinary income upon exercised, and not as capitalgains when the stock is eventually sold.• All options should be subject to a “challenging performance criteria” so that the optioncannot be exercised unless the criteria are met. Executives should not be rewarded forincreases in share prices or other indicators which reflect general price inflation, generalmovements in the stock market, or movements in a particular sector of the market.• As a preferable alternative to stock options, companies should consider performanceshare plans, in which shares are awarded if “challenging performance criteria” arefulfilled, provided that the executives hold the shares for a substantial period.In response to the Greenbury report and the ongoing controversy, the governmenttightened the restrictions on approved option awards (i.e., those treated as capital gains ratherthan ordinary income), reducing the amount that could be awarded to executives (expressedas the aggregate exercise price) from the greater of £100,000 or four times cash emolumentsto only £30,000. In addition, the influential Association of British Insurers (ABI) issuedguidelines effectively constraining the issuing of options – approved and unapproved – tofour times cash compensation. 100100 See, for example, Association of British Insurers (1994); Association of British Insurers (1995).-87-
THE EXECUTIVE COMPENSATION CONTROVERSY: 24 MAY 2010A TRANSATLANTIC ANALYSISFigure 3.3 CEOs in UK Firms receiving equity-based compensation, 2000-2008Note:Sample is based on BoardEx data and include UK CEOs in firms with revenues exceeding €100 million.While the Greenbury report was not legally binding, most UK firms complied with itsrecommendations within a few years after its release. As a result, stock options granted in theUK since Greenbury typically vest only upon attainment of some performance criteria, oftenbased on earnings-per-share growth. In addition, many companies replaced their option planswith performance share plans (or added performance share plans on top of option plans).Figure 3.3 shows the percentage of UK companies that made performance option orperformance share grants to their CEOs between 2000 and 2008. In 2000, 23% of UKcompanies offered performance-vesting stock options to their executives (constituting 3% ofpay for the average CEO), while 60% offered performance shares (constituting 23% of payon average). By 2000, only 18% of the companies offered options (constituting only 1.3% ofpay), while nearly 80% offered performance shares (averaging 30% of pay).Juxtaposing the USA and UK cases yields an interesting lesson in path dependence,showing how small differences in events can lead to large differences in outcomes. CEO paybecame highly controversial in both the USA and UK at about the same time (i.e., in theearly 1990s). Both controversies largely focused on gains realized from stock options at atime when the general economy was poor and company layoffs were prevalent. The UKcontroversy had the added (and important) element that key source of the outrage focused on-88-
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