The CSR Newsletters are a freely-available resource generated as a dynamic complement to the textbook, Strategic Corporate Social Responsibility: Sustainable Value Creation.

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Monday, January 25, 2016

Strategic CSR - Stock options

The article in the url below presents further evidence to suggest that stock options are not as effective a performance incentive as their proponents would like to believe:
"Boards of directors use large packages of stock options to encourage chief executives to attempt bold initiatives with big potential upside for investors. But those options may be spurring CEOs to take excessive risks, according to new research … which linked the size of CEO stock-option grants to the number of product-safety recalls at the chief's company."
The effect is substantial:
"[The researchers found that] increasing the makeup of CEO pay from 25% options to 75% options raises the probability of a subsequent product recall by 35%."
The reason offered is that stock options present executives with a no-lose situation. They constitute a moral hazard in the same way individual traders within the finance industry are encouraged to take risks – the gains are privatized (accruing to the individual and a narrow set of stakeholders) while the risks are socialized (borne by the firm's broader set of stakeholders and, in the last resort, society as a whole):
"Unlike stock grants, in which executives lose money when initiatives fall flat, option grants carry little downside for executives. CEOs stand to make a lot of money by exercising stock options if a big bet like a new drug or product pays off. Yet if that bet fails, executives are no worse off."
The article also contains a potentially more important finding from the study. It is buried in the final paragraph, but is perhaps more instructive for Boards looking to appoint executives who are least likely to endanger the organization:
"The researchers also found that CEOs with tenures of 10 years or more didn't seem to be affected by higher levels of stock-option grants."
Take care
David Chandler & Bill Werther
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Big Stock Options Lead to High Recall Probability
By Rachel Emma Silverman
September 23, 2015
The Wall Street Journal
Late Edition – Final