The next huge outcry over executive pay is likely to erupt when executives cash in on what compensation experts are calling “rebound pay.” That is, the huge stock payouts executives are likely to receive when they exercise stock grants or options that were issued when stock prices were at an all-time low in March 2009.
The reason: the Dow Jones Industrial Average is already 33 percent higher than that low point and many of those options still have three more years to increase in value before they expire.
“Companies have given out a lot of stock awards and that will be a bad thing when the market picks up and executives exercise options granted when prices were low,” said Charles Elson, director of the John L. Weinberg Center for Corporate Governance at the University of Delaware. “You are going to see some big numbers and people are going to squawk about it, as they should,” because the gains will be based on a general improvement in the stock market performance and not improved corporate performance.
Sarah Anderson, director of the Global Policy Center at the Institute for Policy Studies and lead author of the institute's executive compensation reports, agreed.
“Giving stock or options at a point when the economy is in recovery from a major crash [is simply] easy money for executives,” Anderson said. “When you get hundreds of thousands or even millions of shares or options, it doesn't take much of an increase in the stock value for them to really rake it in. Meanwhile, the stock held by long-term shareholders may still be worth less than it was before the crash. And this is all particularly disturbing when the recovery has been fueled by taxpayer support — not managerial genius.
“This is one more sign of the fact that we do not have a pay-for-performance system,” she said. “Instead of being hurt by the crisis like so many of the rest of us, many executives actually turned the crisis into a springboard for greater windfalls. It reinforces the view that the rules of the game are rigged and no matter what these guys do, they always come out ahead. It is outrageous.”
But others argue that is precisely how options are supposed to work, with some paying off and others having no value because they are underwater.
“You are seeing a lot of pay fluctuating and whether an executive walks away with a lot of money or whether that award is minimized depends on the stock market,” said Aaron Boyd, research manager for Equilar Inc., an executive compensation research firm in Redwood City, Calif.
A report published in May by Equilar, for example, found that 68.4 percent of options granted in 2008 were underwater at the time of the study, but that 87.5 percent of the options granted in 2009 were in the money.
“In 2008, the awards were a lot higher valued, but many of those were underwater at the end of 2009,” said Boyd. “Contrast that with 2009, where 87.5 percent of the awards were in the money.”
“A number of executives had a good portion of their previous grants underwater and the probability of those grants having value will be almost zero,” said Christine Oberholzer Skizas, senior consultant and practice leader for executive compensation in the Chicago office of Towers Watson & Co. “Besides, [long-term incentive] should be different from year-to-year and hopefully, over time, average out.”
Anderson could not disagree more strongly.
She said that although executives argue that the system is working because many of the options they were granted in 2008 are underwater, that could not be further from the truth.
“Corporate boards would … like us to believe pay-for-performance works,” she said in her most recent executive compensation report. “But, in reality, it only 'works,'” she said, “as a perpetual upward motion machine for executive compensation, a finely tuned contraption designed to generate windfalls year after year.
“Corporate boards so often react to [stock option] declines by handing executives new batches of stock options, all exercisable down the road at the current low share price,” Anderson said. “And if share prices should sink even lower the next year, boards will hand out still more option 'incentives,' all exercisable at an even lower price.”
What's more, Anderson said, “boards of directors also routinely increase the number of shares their executives can option whenever hard times hit to make future windfalls even more certain. With more shares in play, even a tiny rebound in share price can translate into a handsome reward” for executives without much of a benefit to shareholders, she said.