Skip to main content
SpringerLink
Log in

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

  • Published:
Journal of Business Ethics Aims and scope Submit manuscript

Abstract

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.

This is a preview of subscription content, log in via an institution to check access.

Access this article

Log in via an institution

Price excludes VAT (USA)
Tax calculation will be finalised during checkout.

Instant access to the full article PDF.

Institutional subscriptions

Similar content being viewed by others

References

  • Accounting Principles Board: 1972, ‚APB Opinion No. 25: Accounting for Stock Issued to Employees’, Reprinted by the Financial Standards Board in Original Pronouncements, Vol II, Wiley

  • Akhigbe A., Madura J., Tucker A. L. 1996 Market-Controlled Stock Options: A New Approach to Executive Compensation. Journal of Applied Corporate Finance 9:93–97

    Article  Google Scholar 

  • Angel J. J., McCabe D. M. 2002 Market-Adjusted Options for Executive Compensation. Global Business and Economics Review 4:1–23

    Article  Google Scholar 

  • Antle R., Smith A. 1986 An Empirical Examination of the Relative Performance Evaluation of Corporate Executives. Journal of Accounting Research 24:1–39

    Article  Google Scholar 

  • Arya A., Sun H. L. 2004 Stock Option Repricing: Heads I Win, Tails You Lose. Journal of Business Ethics 00:1–16

    Article  Google Scholar 

  • Ashley A. S., Yang S. S. M. 2004 Executive Compensation and Earnings Persistence. Journal of Business Ethics 50:369–382

    Article  Google Scholar 

  • Baviera, G. J. and L. M. Walther: 2004, ‚Stock Option Accounting: Defying the Usual Answers’, CPA Journal May 2004, 36

  • Bebchuk L. and J. Fried: 2004, Pay without Performance: The Unfilled Promise of Executive Compensation (Harvard University Press, Cambridge, MA)

  • Black, F. 1986 Noise. Journal of Finance 41:529–543

    Article  Google Scholar 

  • Black F., Scholes M. 1973 The Pricing of Options and Corporate Liabilities. Journal of Political Economy 81:627–654

    Article  Google Scholar 

  • Bloom M., Milkovich G. T. 1998 Relationships Among Risk, Incentive Pay, and Organizational Performance. Academy of Management Journal 41:283–297

    Article  Google Scholar 

  • Bolton, P., J. A. Scheinkman and W. Xiong: 2006, ‚Executive Compensation and Short-Term Behavior in Speculative Markets’, Review of Economic Studies, forthcoming

  • Brownstein, A. R. and M. J. Panner: 1992, ‚Who Should Set CEO Pay? The Press? Congress? Shareholders?’ Harvard Business Review 70, 28–32, 34–35, 38

    Google Scholar 

  • Buchholtz A. K., Ribbens B. A. 1994 Role of Chief Executive Officers in Takeover Resistance: Effects of CEO Incentives and Individual Characteristics. Academy of Management Journal 37:554–579

    Article  Google Scholar 

  • Chan, K., L. Chan, N. Jegadeesh and J. Lakonishok: 2006, ‚Earnings Quality and Stock Returns’, Journal of Business, 79, 1041–1082

    Google Scholar 

  • Conyon M. J., Peck S. I. 1998 Board Control, Renumeration Committees, and Top Management Compensation. Academy of Management Journal 41:146–157

    Article  Google Scholar 

  • Coopers and Lybrand L. L. P.: 1995, Understanding FASB Statement No. 123 (Coopers and Lybrand, New York)

  • Crystal G. S. 1991a Why CEO Compensation is So High. California Management Review 34:9–29

    Google Scholar 

  • Crystal, G. S.: 1991b, In Search of Excess: The Overcompensation of the American Executive (W.W. Norton, New York)

  • Cuny C. J., Jorion P. 1995 Valuing Executive Stock Options with Endogenous Departure. Journal of Accounting and Economics 20:193–205

    Article  Google Scholar 

  • Daily C. M., Johnston J. L., Ellstrand A. E., Dalton D. R. 1998. Compensation Committee Composition as a Determinant of CEO Compensation. Academy of Management Journal 41:209–220

    Article  Google Scholar 

  • Deckop J. R. 1988 Determinants of Chief Executive Officer Compensation. Industrial and Labor Relations Review 41:215–225

    Article  Google Scholar 

  • Donaldson T., Preston L. E. 1995 The Stakeholder Theory of the Corporation: Concepts, Evidence, and Implications. Academy of Management Journal 33:663–691

    Google Scholar 

  • Eisenhardt K. M. 1985 Control: Organization and Economic Approaches. Management Science 31:134–149

    Article  Google Scholar 

  • Fama E. F., French K. R. 1992 The Cross Section of Expected Stock Returns. Journal of Finance 47:427–465

    Article  Google Scholar 

  • Financial Accounting Standards Board: 1995, Financial Accounting Standard 123: Accounting for Stock-Based Compensation

  • Finkelstein S., Boyd B. K. 1998 How Much Does the CEO Matter? The Role of Managerial Discretion in the Setting of CEO Compensation. Academy of Management Journal 41:179–199

    Article  Google Scholar 

  • Frankfurter G. M. 1995 The Rise and Fall of the CAPM Empire. Financial Markets, Institutions, and Instruments 4:5104–5127

    Google Scholar 

  • Gawande, A.: 2005, ‚Medicine’s Money Problem’, The New Yorker, April 4, 2005

  • Gerhart B., Milkovich G. T. 1990 Organizational Differences in Managerial Compensation and Financial Performance. Academy of Management Journal 33:663–691

    Article  Google Scholar 

  • Gerhart, B. A. and S. Rynes: 2003, Compensation: Theory, Evidence, and Strategic Implications, Sage Publications

  • Gibbons R., Murphy K. J. 1990 Relative Performance Evaluation for Chief Executive Officers. Industrial and Labor Relations Review 43(suppl):30S–51S

    Article  Google Scholar 

  • Gilson S., Vetsuypens M. 1993 CEO Compensation in Financially Distressed Firms: An Empirical Analysis. Journal of Finance 48:425–458

    Article  Google Scholar 

  • Gomez-Mejia L. R., Tosi H., Hinkin T. 1987 Managerial Control, Performance, and Executive Compensation. Academy of Management Journal 30:51–70

    Article  Google Scholar 

  • Grasskamp, E. D.: 1989, ‚Long-Term Incentives for Management. Part 2. Stock-Price Appreciation Grants’, Compensation and Benefits Review (September), 29–43

  • Grossman S. J., Hart O. D. 1983 An Analysis of the Principal Agent Problem. Econometrica 51:7–45

    Article  Google Scholar 

  • Henderson A. D., Frederickson J. W. 2001 Top Management Team Coordination Needs and the CEO Pay Gap: A Competitive Test of Economic and Behavioral Views. Academy of Management Journal 44:96–117

    Article  Google Scholar 

  • Hill C. W. L., Phan P. 1991 CEO Tenure as a Determinant of CEO Pay. Academy of Management Journal 34:707–717

    Article  Google Scholar 

  • Holmström B. 1979 Moral Hazard and Observability. Bell Journal of Economics 10:74–91

    Article  Google Scholar 

  • Holmström B. 1982 Moral Hazard in Teams. Bell Journal of Economics 13:324–340

    Article  Google Scholar 

  • Huddart S. 1994 Employee Stock Options. Journal of Accounting and Economics 18:207–232

    Article  Google Scholar 

  • Investor Responsibility Research Center Inc.: 1999, Social Policy Shareholder Resolutions in 1999: Issues, Votes and Views of Institutional Investors, January 2000 (IRRC, Social Issues Service, Washington, DC), pp. 1–62

  • Investor Responsibility Research Center Inc.: 2003, 2003 Social Policy Proxy Season Guide, A Complete Guide to U.S. Social Policy Shareholder Resolutions Coming to Votes April 1–June 30, 2003 (IRRC, Social Issues Service, Washington, DC), pp. 1–172

  • Jana-kiraman S., Lambert R., Larcker D. 1992 An Empirical Investigation of the Relative Performance Evaluation Hypothesis. Journal of Accounting Research 30:53–69

    Article  Google Scholar 

  • Jensen M. C., Meckling W. H. 1976 Theory of the Firm: Management Behavior, Agency Costs, and Ownership Structure. Journal of Financial Economics 3:305–360

    Article  Google Scholar 

  • Jensen M. C., Murphy K. J. 1990 CEO Incentives – It’s Not How Much You Pay, but How. Harvard Business Review 68:138–149

    Google Scholar 

  • Jensen M. C., Murphy K. J. 1990 Performance Pay and Top-Management Incentives. Journal of Political Economy 98:225–264

    Article  Google Scholar 

  • Jones T. M. 1995 Instrumental Stakeholder Theory: A Synthesis of Ethics and Economics. Academy of Management Review 20:404–433

    Article  Google Scholar 

  • Kafka, P.: 2005, ‚Special Report: The Celebrity 100’, Forbes, http://www.forbes.com/ celebrity100/

  • Kerr J., Bettis R. A. 1987 Board of Directors, Top Management Compensation, and Shareholder Returns. Academy of Management Journal 30:645–664

    Article  Google Scholar 

  • Kerr J. L., Kren L. 1992 Effect of Relative Decision Monitoring on Chief Executive Compensation. Academy of Management Journal 35:370–397

    Article  Google Scholar 

  • Lambert R. A., Larcker D. F., Verrecchia R. E. 1991 Portfolio Considerations in Valuing Executive Compensation. Journal of Accounting Research 29:129–149

    Article  Google Scholar 

  • Lang, M. H.: 2004, ‚Employee Stock Options and Equity Valuation’, Research Foundation of CFA Monograph, http://www.cfapubs.org/rf/issues/v2004n2/toc.html

  • Matsumura E. M., Shin J. Y. 2005 Corporate Governance Reform and CEO Compensation: Intended and Unintended Consequences. Journal of Business Ethics 62:101–113

    Article  Google Scholar 

  • McConvill, J. A.: 2005, ‚Executive Compensation in Contemporary Corporate Governance: Why Pay for Performance is a Flawed Methodology’, http://ssrn.com/abstract=723521

  • Merrion, P.: 2006, ‚Wiping the Slate Clean to Avoid a Nick in ‚06; Some Area Firms Speed Up Vesting of Stock Options to Avoid a Profit Hit. Crain’s Chicago Business, January 2, p. 4

  • Miller D. J. 1995 CEO Salary Increases may be Rational After All: Referents and Contracts in CEO Pay. Academy of Management Journal 38:1361–1385

    Article  Google Scholar 

  • Mozes H. A. 1995 An Upper Bound for the Firm’s Cost of Employee Stock Options. Financial Management 24:466–477

    Article  Google Scholar 

  • Murphy K. J. 1985 Corporate Performance and Managerial Remuneration: An Empirical Analysis. Journal of Accounting and Economics 7:11–42

    Article  Google Scholar 

  • Nichols D., Subramanian C. 2001 Executive Compensation: Excessive or Equitable? Journal of Business Ethics 29:339–351

    Article  Google Scholar 

  • O’Byrne S. F. 1995 Total Compensation Strategy. Journal of Applied Corporate Finance 8:77–86

    Article  Google Scholar 

  • Oviatt B. M. 1988 Agency and Transportation Cost Perspectives on the Manager-Shareholder Relationship: Incentives for Congruent Interests. Academy of Management Review 13:214–225

    Article  Google Scholar 

  • Perel M. 2003 An Ethical Perspective on CEO Compensation. Journal of Business Ethics 48:381–391

    Article  Google Scholar 

  • Platt H. D. 1987 Determinants of Executive Compensation: The Neoclassical Versus Concept Formulation. Journal of Economics Psychology 8:255–272

    Article  Google Scholar 

  • Pound J. 1995 The Promise of the Governed Corporation. Harvard Business Review 73:89–98

    Google Scholar 

  • Rappaport, A.: 1999, ‚New Thinking on How to Link Executive Pay with Performance’, Harvard Business Review, March

  • Rediker K. J., Seth A. 1995 Boards of Directors and Substitution Effects of Alternative Governance Mechanisms. Strategic Management Journal 16:85–99

    Article  Google Scholar 

  • Rodgers W., Gago S. 2003 A Model Capturing Ethics and Executive Compensation. Journal of Business Ethics 48:189–202

    Article  Google Scholar 

  • Ross, S. A.: 1976, ‚The Arbitrage Theory of Capital Asset Pricing’, Journal of Economic Theory, December

  • Saly P. J. 1994 Repricing Executive Stock Options in a Down Market. Journal of Accounting and Economics 18:325–356

    Article  Google Scholar 

  • Sharpe W. F. 1964 Capital Asset Prices: A Theory of Market Equilibrium Under Conditions of Risk. Journal of Finance 19:425–442

    Article  Google Scholar 

  • Spikes, S.: 2005, ‹Top European Investment Bankers may Reap a 20% Gain in Year-End Bonuses’, The Wall Street Journal, Novermber 16, 1

  • Thomas, R. S., J. E. Core and W. R. Guay: 2005, ‚Is US CEO Compensation Broken?’ Journal of Applied Corporate Finance 17(4)

  • Tosi H. L., Gomez-Mejia L. R. 1989 The Decoupling of CEO Pay and Performance: An Agency Theory Perspective. Administrative Sciences Quarterly 34:169–189

    Article  Google Scholar 

  • Tosi H. L., Gomez-Mejia L. R. 1994 CEO Compensation Monitoring and Firm Performance. Academy of Management Journal 37:1002–1016

    Article  Google Scholar 

  • U.S.A. Today: 2006, USA Today Salaries Database, http://asp.usatoday.com/sports/baseball/salaries/mediansalaries.aspx?year=2005

  • Ubelhart M. 1985 Business Strategy, Performance Measurement, and Compensation. Midland Corporate Finance Journal Winter:67–75

    Google Scholar 

  • United States House of Representatives: 2004, Stock Option Accounting Reform Act, 108th Congress, HR 3574. http://frwebgate.access.gpo.gov/cgi-bin/getdoc. cgi?dbname=108_cong_bills&docid=f:h3574eh.txt.pdf

  • Walsh J. P., Seward J. K. 1990 On the Efficiency of Internal and External Corporate Control Mechanisms. Academy of Management Review 15:421–458

    Article  Google Scholar 

  • Warner J. B., Watts R. L., Wruck K. H. 1988 Stock Prices and Top Management Changes. Journal of Financial Economics 20:461–492

    Article  Google Scholar 

  • Werner S., Tosi H. L. 1995 Other People’s Money: The Effects of Ownership on Compensation Strategy and Managerial Pay. Academy of Management Journal 38:1672–1691

    Article  Google Scholar 

  • Wilhelm, P. G.: 1993, ‚Application of Distributive Justice Theory to the CEO Pay Problems: Recommendations for Reform’, 12, 469–482

Download references

Author information

Authors and Affiliations

  1. The McDonough School of Business, Georgetown University, Washington, DC, 20057, U.S.A.

    James J. Angel & Douglas M. McCabe

Authors
  1. James J. Angel
    View author publications

    You can also search for this author in PubMed Google Scholar

  2. Douglas M. McCabe
    View author publications

    You can also search for this author in PubMed Google Scholar

Corresponding author

Correspondence to James J. Angel.

Additional information

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.

Rights and permissions

Reprints and permissions

About this article

Cite this article

Angel, J.J., McCabe, D.M. The Ethics of Managerial Compensation: The Case of Executive Stock Options. J Bus Ethics 78, 225–235 (2008). https://doi.org/10.1007/s10551-006-9326-8

Download citation

  • Published:

  • Issue Date:

  • DOI: https://doi.org/10.1007/s10551-006-9326-8

Keywords

Search

Navigation