Stock Option and Ethics - Principles of Financial Accounting

Stock Option and Ethics
Carol Berry
ACC201 Principles of Financial Accounting
Instructor: David Miller
August 1, 2011

Stock Option and Ethics In today’s corporate world stock options makes up and is increasingly dominates CEO pay packages. CEO’s and top level executives are paid in a variety of different ways and stock options are just one of the ways that they get paid. CEO’s and executives have skills and responsibilities that allow directors of companies to pay these executives an extremely high rate of pay. To sometimes find other ways than a monetary wage the directors will pay their executives in stock options or different benefits. In this essay I will look at the stock options and some of the ethical problems that these stock options cause. Most CEO’s are paid through a “base pay, annual bonuses, long-term incentives, restricted stock awards, and stock options.” (Salary.com, 2011) As a general rule “the base salary accounts for about 20 percent and the other 80 percent is performance-based pay.” (Salary.com) Base pay is usually based upon the core basics and responsibilities of running the company on a day to day basis. Then you have the annual bonuses which are distributed because the executive has met annual performance expectations that were set at the on-set of employment or upon the previous year’s review. Long-term incentive payments are given for performance objectives that have been met over usually a two – to five – year period. Restricted stock awards are given so that the CEO and executives interests are aligned with the share holders; this is because restricted stock awards have an actual cash value. Stock options are used because they are very favorable for the accounting of the company. Stock options are tied directly to the performance of the executive and the company when the executive is making good and sound decisions then the company will profit from this and so too will the executive. Executives are compensated by the difference of the stock price at the date of the grant (or strike price) and the stock price on the date of exercise. The executive has an incentive to increase the company’s stock price, this means if the stock goes up the executive has the right to exercise his option for profit. If the stock does not go up than there is no gain for the executive. Usually the stock options are granted at the fair market value of the stock price on the date of grant.
What happens when unethical decisions are made? When a decision is made to be unethical it not only effects that person who makes the decision it also effects everyone involved with that person and the company they work for is included. Since a stock option grant is made on a given day, the option grant letter reflects a date in the past when the stock price was lower than the real date of grant. If a person decides to backdate stock option, this allows the recipient to take advantage of the opportune date with low stock price, which will eventually equal greater income when the option is exercised.
CEO’s and executives pay packages are incentive based and stock options are based on the performance of these executives. When an executive makes decisions and those decisions bring the company profits than these profits will also be reflected in stock options incentives to the executive. Any unethical decisions to defraud the company or the government will only cause unnecessary harm to the company the executive and the other shareholders of the company. Not only will it be harmful it can also result in that person or persons being charged with a crime, that could result in expensive attorney fees and even a lengthy prison sentence.

Reference:
Edmonds, T., Olds, P., McNair, F., & Tsay, B. (2012). Survey of accounting (3rd Ed.). New York: McGraw-Hill Irwin
Sarlary.com, 2011, Retrieved from website: http://www.salary.com/Articles/ArticleDetail. asp?part=par404, on July 29, 2011