Executive Privilege?

Here's the New Take on Stock Options: They Reward Corporate Leaders for All the Wrong Things.

In his folksy annual letter to shareholders of Berkshire Hathaway Inc. last month, Chairman Warren E. Buffett related a joke making the rounds in corporate boardrooms:

"A gorgeous woman slinks up to a CEO at a party and through moist lips purrs, 'I'll do anything -- anything -- you want. Just tell me what you would like.' With no hesitation he replies, 'Reprice my [stock] options.' "

The joke was Buffett's way of making the more serious point that the alleged misdeeds and misjudgments that have come to plague companies such as Enron and Global Crossing and Tyco International are really manifestations of a much broader and more pernicious problem: the single-minded focus of corporate executives on boosting their companies' stock price.

At worst, recent history shows that share-price obsession has driven some executives to improperly, and perhaps illegally, misrepresent their companies' financial condition to investors, who later lost many millions when the true picture was revealed. But even at companies that have continued to prosper, executives report that the general fixation on daily and weekly stock-price movements drives them to manage for the short term, sacrificing the long-term interest of shareholders and employees.

There was nothing inevitable about this development -- it didn't use to be that way, executives say, and in other countries it still isn't. But over the past 20 years, as American capitalism has morphed into shareholder capitalism, virtually all the incentives and disincentives that have been brought to bear on the executive suite are linked directly or indirectly to short-term movements in the company stock price.

The stock price is now the overwhelming factor in determining the pay of top company officials, with tens of millions of dollars at stake every year.

It is the yardstick by which Wall Street's analysts and money managers declare which companies are most worthy, and it is the cue for much of the financial press in deciding which managers are to be lionized and which are to be ignored, or even vilified.

A rising stock price is the CEO's best defense against an unwanted takeover or an unceremonious sacking by the board of directors.

And in an era whenan increasing share of employees' retirement funds are tied up in their companies' stock, the direction of the share price has become a key factor in the motivation and loyalty of many employees.

Like it or not, the short-term impact on the stock price has become the metric against which nearly all major corporate decisions are judged. It drives decisions on what to buy and when to sell, whom to hire and how much to invest -- and whether to put any of it on the books or off. "Everyone in the system has an incentive to do whatever it takes to keep the stock price up," said William T. Allen, director of the Center for Business and Law at New York University. "But we don't know how to control the risks inherent in these incentive structures."

"What we have now is a totally rational system within a completely irrational box," explains Jeffrey Garten, dean of the Yale School of Management.

Getting the incentives and disincentives right has now become Topic A in Washington and in boardrooms across the country, where directors and top executives are scrambling to fix what ails American capitalism and prevent another round of high-profile corporate collapses.

The fear in the business community is that reforms will go beyond what is necessary to discourage unethical behavior and short-termism and wind up discouraging the kind of good risk taking that has been the core of America's economic success.

The view among reformers is that in a highly competitive environment, no company can be expected to do the right thing unless everyone is forced to. And that without such tougher laws and regulations, investors will lose confidence in capital markets and the economy will be doomed to go through exaggerated boom and bust cycles with unacceptable economic and social costs.