Executive Compensation: Realized Option Pay

by Malak Kazan, CECP, CCP, CBP, GRP 26. April 2011 13:50

The October 2010 study of executive compensation, “What do CEOs Realize from Option Pay?” by Mark Anderson and Volkan Muslu of the School of Management, the University of Texas at Dallas, looks at the estimated fair market value versus realized value of CEO options pay relative to incompleteness of option transfer rights and tenure with company. The study considers the incompleteness of the transfer of option rights to the CEO at grant date due to performance vesting conditions, black-out and minimum equity holding restrictions, and forced exercise or forfeiture provisions upon resignation. Also, the authors discuss the flaw in relying on values derived from option pricing models since they do not factor in the performance vesting contingencies, and the distribution of outcomes is not as balanced as is anticipated in the models (e.g., Black Scholes), resulting in an asymmetrical option payout structure. The study also looks at externally versus internally hired CEOs, as well as how this factor influences the cash realization of option pay.

Using pay data of 1,403 CEOs who began and ended their tenures at all S&P 1500 companies between 1992 and 2007, their findings include the following:

• 29% of CEOs stayed in their positions for less than two years and realized only 16% of their nominal option pay.

• 31% of CEOs stayed between two and four years and realized 40% of their nominal option pay.

• 20% of CEOs stayed between four and six years and realized 57% of their nominal option pay.

• 12% of CEOs stayed between six and eight years and realized 77% of their nominal option pay.

• CEOs with eight years or longer tenure realized proceeds equal on average to their nominal option pay.

• Similar relationship exists between firm performance, CEOs’ tenure, and realized option pay.

For more details on this study, see http://business.gwu.edu/accountancy/files/effect-mandatory-ifrs-adoption.pdf.