A persistent tingle in my left nostril tells me that my esteemed colleague and opponent Rick Munarriz will bring up all the ways you can abuse stock options. In a preemptive response to that concern, let me quote that noted modern philosopher, Spider-Man: "With great power comes great responsibility." The Marvel (NYSE: MVL ) hero could easily have been talking about one of the most powerful and misunderstood motivational tools available to today's corporate managers.
Trickle-down economics
Stock-based compensation is commonly used to hand out stock options or straight-up shares in your company to the top brass in management. It's meant to motivate top executives to keep the company running as well as it possibly can; they will directly benefit from an improving stock price, which is one expected result of running a great operation.
For an example of doing this right, look at Rodney Sacks, CEO and chairman of Hansen Natural (Nasdaq: HANS ) . This company has disclosed options grants for years, even though it didn't technically have to, so it's easy to find out how its CEO was compensated for his work.
In return for making the Monster energy drink a serious threat to privately held Red Bull, Sacks received options on 450,000 shares of Hansen stock over the past five years, along with an average of $284,000 in straight salary (plus cash bonuses). The stock now trades at $200 per share; you do the math.
It didn't take any dirty backdating tricks or secret allotments to reward the CEO of one of the market's best-performing stocks over the last decade. Management was simply rewarded for stellar performance and motivated to stay with the company through SEC vesting rules that invalidate unused options if executives leave a company. It's all on the up-and-up. I'm cool with that, and presumably so are Hansen's shareholders.
From the ground up
The top dogs aren't the only ones who can benefit from stock-based pay. Remember the heady dot-com days? If you were a janitor or a mailroom clerk at Yahoo! (Nasdaq: YHOO ) or Vignette (Nasdaq: VIGN ) at the right time, and you took options as part of your pay package, you became very rich, very fast. The mere promise of that kind of windfall is one way to stock up on talented (and greedy) employees, and to keep them around as long as the future still looks bright. It's profit-sharing without the immediate tax impact, and again, that's a great motivator for employees to do the best job they can.
Did I mention taxes? The most restrictive options grants, where the stock resulting from exercising your options can't be sold for another year thereafter, can give you tax-free gains when you finally do sell the stock. Look for "incentive stock options" in your next contract. They could make you rich.
Summa summarum
I know there are problems with options, but they all seem to arise from weak disclosure rules. The Fool has lobbied long and hard for greater transparency in grant policies, and now these grants need to be disclosed as operating expenses. That's a start, but it's about to get even better.
The SEC is set to vote on changes to the reporting rules concerning executive pay. If the measure succeeds, all publicly traded companies will be required to list the shares and options held by the five highest-paid employees, and even Hansen will have to add the monetary value of these incentives to its earnings reports.
With that level of clarity, the market will be able to punish companies doing stupid option tricks like backdating, thereby making infractions even less common. As Spidey might say: "With great transparency comes great accountability."
Think you're done with the Duel? You're not! Go back and read the other three arguments, and then vote for a winner.
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Fool contributor
Anders Bylund
owns no stock in the companies discussed this week, but he does drink a lot of Monster. Foolish disclosure is the very model of transparency.
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