Stock_Options_1 - The Stock Option Travesty...

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The Stock Option Travesty  By Whitney Tilson 03/20/2002  At one time, I was somewhat agnostic about stock options. While I have never agreed with the accounting for  them, I felt that by giving options to management and employees of companies, it would help align their interests  with those of shareholders. But what began as a good idea on a limited scale -- one that might have even  benefited shareholders -- has morphed into a monster that has run amok, harming companies and shareholders  tremendously. Immediate, significant reform is needed to curb stock option excesses.  The basics  Almost all major public companies in America issue stock options to management and/or employees. While there  are different types of options (mainly qualified and nonqualified) and countless flavors of option programs, the key  features tend to be the same: At regular intervals (often annually), a company issues certain employees a fixed  number of options, generally with a ten-year life, a strike price at or near the current stock price, and a four- to five- year vesting period (meaning that employees can only convert 20-25% of each batch of options granted into stock  each year). If the stock rises, employees over time can exercise their options, receive stock, and profit from the  difference between the strike price they pay and the price at which they sell the stock.  The benefits  Since options will eventually expire worthless if the stock price doesn't rise, they can certainly motivate employees  to focus on getting the stock price up. This can be a good thing if it's done legitimately through growth in the  intrinsic value of the business, rather than through Enron-style smoke and mirrors.  Options also help a company retain its most valued employees -- presumably the ones who receive the most  options -- because any employees who leave the company forfeit their unvested options. Finally, options can be a  fair way to reward outstanding performance. Let's say management excels and doubles the profits of a company  over time, triggered a doubling of the stock price. Isn't it reasonable that management should profit from this stock  appreciation?  Given these notable benefits, what's the problem? My issues fall into three areas: dilution, bogus accounting, and 
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perverse incentives. 
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This note was uploaded on 04/20/2011 for the course ACC 101 taught by Professor Xyz during the Spring '11 term at Ohio State.

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Stock_Options_1 - The Stock Option Travesty...

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