Stock options plans: Solving agency issues

Abstract

Internal decision-making processes of companies are not a truly homogeneous process taking into consideration all parties to a company. On the contrary, it is a reflex of the intention of an entitled few that finds legitimacy in corporate structure. An efficient alignment of interests of all parties is crucial and attainable through remuneration policies, and specifically, through variable and performance-driven compensation. After all, these interests are essentially economic interests. In this paper, the focus is stock options plans as a solution to agency issues. Because options stimulate the acquisition of shares of the company, management tends to have more skin on the game, discouraging excessive risk taking but also entailing long-term commitment with the company. We believe that the best solutions for most companies are not necessarily the best solution for all of them. For that matter, a number of similar instruments are reviewed as well as different categories of stock options. We conclude that corporate governance mechanisms can be adapted to mitigate stock options plans’ weaknesses. Solutions may be, for example, balanced strike prices – with great caution in the cases of premium options and performance-vested options and equal caution when using indexes as assessment parameters of the management’s performance. The fact that solutions are found in corporate governance to solve issues within stock options plans, leads to the conclusion that criticism regards the design of stock options plan and not stock options plans themselves.