So argues the Wall Street Journal, in an article that appeared yesterday:
Steven Kaplan, a finance professor at the University of Chicago’s Booth Graduate School of Business, likes stock options as executive compensation in most cases. But he finds it odd that ISS classifies performance-based shares differently than stock options, since the two forms of equity can deliver the same returns and offer the same incentives.
Mr. Kaplan offers an example of an executive who receives three million options with an exercise price of $10. If the stock rises to $15, the executive can make $15 million; if it rises to $20, the executive can make $30 million. Directors can create the same payouts and incentives with a grant of restricted stock, where the executive receives one million shares if the stock rises to $15, and 1.5 million shares if the stock rises to $20.
“The payoffs are identical. Options are not pay-for-performance, but restricted stock is—completely irrational,” he says.
Pretty ironic if true, given the hatred institutional shareholder groups display for options and the adoration they lavish on performance shares.
But is it? (True, that is.) One thing the article mostly ignores is that performance shares are generally earned based on relative, rather than absolute, TSR performance. In other words, performance shares are generally earned only to the extent the company’s TSR outperforms the TSR of a selection of peer companies. Performance shares generally aren’t designed to pay out on the achievement of absolute TSR numbers. Stock options, in contrast, generally provide value for any increase in share price, regardless of relative performance.
So performance shares and stock options typically have a lot less in common than the article suggests. The more accurate comparison, perhaps, would be to stock options with an indexed strike price… something most shareholder groups, I imagine, would be fine with.