|Man Without Qualities|
Monday, July 29, 2002
There is a very fine opinion piece by Robert Bartley in the Wall Street Journal regarding the pitfalls of "expensing" option a la Warren Buffet.
The bottom line of the Bartley argument is that "expensing options" would make the bottom line of corporate financials less reliable and more confusing, at least to "ordinary investors" who don't work with option pricing equations.
At the same time, the Journal runs a remarkably bad options piece by Susan Lee, which serves up arguments that have been made for months (decades, if one counts the pure academic discussions) in other quarters as if they were fresh. Sample quote: "Well, now comes Brian J. Hall, economics professor at the Harvard Business School, to explain. In a recent paper, Executive Compensation and Ownership Structure (www.people.hbs.edu/bhall/ec), Mr. Hall argues that options are leveraged instruments."
Options are leveraged instruments? My goodness, we certainly need a nabob from HBS to tell us that! All those options traders in Chicago who have been pricing options using those Black-Scholes buttons on their calculators for the last few decades will just be decked!
It seems that Professor Hall and Ms. Lee think that options should be expensed because that would make it easier for companies to give their executives and employees restricted stock. Of course, no analysis is provided of any of the incentive problems created by restricted stock grants. No mention is made of what might be done in structuring the option program to reduce problems with option grants - but a board of directors that seriously represents shareholder interests can do a lot with such structuring. And if one posits a board of directors that does not represent shareholder interests (the real underlying issue here), might there be a little issue or two with allowing that board to grant large blocks of the already accumulated value of the company to existing management? Nor is there a word on the number of shares that have to go out the door as restricted stock to get the intended incentive effect. And while a few word are offered about the obvious if delicate need for companies to reprice or refresh options that have been submerged in appropriate cases, no criticism of the currently fashionable demonization of such practices is offered. How about a mention of the partial economic similarity of (i) options with a strike price less than stock price in effect on the day of the grant, on the one hand, and (ii) restricted stock grants, on the other hand (could that mean that options are more flexible and could capture many of the benefits of stock grants without some of their disadvantages)? No. I guess there just wasn't room for those details. Worse, because the Hall paper makes a virtual Marti Gras out of confusing objective economic incentives considerations with corporate "behavioral" considerations (read, "what boards who may or may not represent shareholder interests do"), it entirely confuses the separate issues of (i) what economic incentives are created by options as opposed to stock grants and (ii) how are boards of directors dealing with those incentives. The artificial and ad hoc concept if "option fragility" is arbitrarilly elevated by the paper to a position of supreme significance without serious evaluation of the economic fundamentals involved. In short, the paper is a complete mess.
Further, we are apparently to believe that public companies have never before seriously considered or understood the relative merits of these two standard compensation structures. For example, Kirk Kirkorian, who owns a solid majority of MGM GRAND, chooses to have that company grant stock options to its executives (who happen to be exceptionally clever). Are we supposed to believe that Mr. Kirkorian is just incapable of grasping the profound differences between options and restricted stock grants that Mr. Hall sees so clearly now?
The Man Without Qualities believes executive compensation issues are tough and unsettled. The matter has been discussed with much greater acuity than Professor Hall brings to the table by both Jane Galt and More Than Zero. I cannot understand why the Wall Street Journal runs a silly puff piece about an HBS professor's paper that appears to add exactly nothing to existing understanding of the matters it discusses. The author, Professor Hall, is no doubt a gifted person, and I do not want to be read as disparaging him generally and I think it's fine that he takes advantage of his opportunities. But in this instance the most objective thing that can be said about his paper is that it - together with the Journal's plump - should be good for some rich speaker fees at a good number of corporate and political lunches, and maybe a consulting contract or two.
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