The Ethics of Managerial Compensation: The Case of Executive Stock Options

This paper examines the ethics of contemporary managerial compensation in the context of executive stock options. Economic considerations would dictate that executive stock options should be adjusted to eliminate the effect of overall stock market movements which are beyond the control of the executive. However, in practice, most executive stock options are not adjusted to control for these outside factors. Agency considerations are the most likely culprit. Adjusting for the influence of outside factors, such as a generally rising stock market, from executive stock options sets a higher bar for managers to reach. Furthermore, traditional accounting standards permitted firms that did not adjust options to avoid reporting options as expenses. This presents CEOs and boards of directors with a major ethical dilemma. On the one hand, their duty to their shareholders and stakeholders dictates that executive stock options should be adjusted to eliminate outside noise from unrelated movements in the overall stock market. However, financial statements are presented in the language of accounting. If the overwhelming majority of the users of a language define a particular item in one way, then to deviate from the norm implies that the recipient of such a deviant statement may not properly interpret the statement. Likewise, if the standard practice is for firms to use unadjusted options and thus under-report expenses, to deviate from this industry norm risks that users of financial statements would not properly interpret the financial statements, with perhaps negative consequences for the shareholders. In short, if “everyone else does it,” then it could be wrong for an individual firm to deviate from the norm as that would harm the shareholders. James J. Angel is an Associate Professor of Finance at the McDonough School of Business at Georgetown University. He is a financial expert whose research focuses on the operation of financial markets in the United States and other countries. He currently serves on the OTCBB Advisory Board, and he has served as Chair of the Nasdaq Economic Advisory Council. He earned his undergraduate degree from the California Institute of Technology, his MBA from the Harvard Business School, and he earned his Ph.D. in Finance from the University of California at Berkeley. Douglas M. McCabe is a Professor of Management at the McDonough School of Business at Georgetown University. He serves on the Editorial Boards of 20 scholarly journals, including Research on Ethical Issues in Organizations, JAI Press as well as the Employee Responsibilities and Rights Journal. Considered by the media to be an expert in his field, he has appeared more than 200 times on international (CNN), national (ABC, NBC, and CBS), and local television and radio. He holds a Ph.D. from Cornell University and is a member of Phi Beta Kappa.