Page 133 - Introduction to Business

CHAPTER 3 Business Governance, Ethics, and Social Responsibility 107

in general a way to accomplish this, but as typically granted, such options do not
usually achieve the desired financial alignment goals.
For example, a typical company might grant its CEO on January 1, 2005, the
right to buy 40,000 shares of its stock at the then-current price of $40 per share. The
right to purchase all of these shares might vest immediately or perhaps over a few
years (e.g., 10,000 shares vest immediately and an additional 10,000 shares vest
annually on January 1, 2006, on January 1, 2007, and January 1, 2008). These stock
options can be exercised any time during the six-year period between January 1,
2005 and January 1, 2011. This stock option scheme thus gives the CEO a lot of flex-
ibility with respect to exercising her or his options and then immediately selling, or
“flipping,” the stock.
For example, in January, 2002, the Tenet Healthcare Corporation CEO Jeffrey C.
Barbakow cashed out options and immediately sold company stock worth $111
million shortly after calling the company’s business sensational and increasing its
profit forecast. Tenet Corporation ended up having a terrible year, missing profit
projections, and being subject to FBI and other investigations. Its stock closed the
year at around $16 per share, down approximately 60 percent from the $43.35 price
received by its CEO when he sold his stock in January. Tenet’s stock was also down
over 25 percent from its price five years previously. 13
In response to the developments regarding Mr. Barbakow and other top execu-
tives reaping tremendous rewards flipping stock options, numerous observers have
called for tying stock options and other stock compensation more firmly to long-
term corporate performance. The Pennsylvania State Employees Retirement Sys-
tem’s chief investment officer Peter M. Gilbert has, for example, said that the stock
option “system has just distorted itself.” Similarly, Richard E. Cavanagh, the chief
14
executive of the Conference Board, a major business research group, has said that
you “can always dress up a company to make it look good” for a short period of time
and that as a result, long holding periods for company stock are needed to “focus
executives on long-term results.” 15
Because of these concerns, a number of major companies, including GE and
WorldCom, now prohibit executives from exercising stock options and then imme-
diately selling the stock. Indeed, WorldCom’s CEO must hold (not sell) 75 percent of
all stock he or she receives from exercising options or otherwise until at least six
months after he or she leaves the company. 16
Another way to perhaps even better align executives’ and directors’ financial
interests with shareholders’ financial interests is to make restricted stock payments restricted stock Corporate stock that
a very significant part of their overall compensation. Such a procedure involves giv- has some restrictions on it, for example,
regarding when it can be sold
ing top executives and directors company stock as remuneration but severally
restricting its sale in a variety of ways; for example, the stock cannot be sold for a
period of at least 10 or 15 years, unless the company gets purchased.
Restricted stock grants work well, in terms of better aligning shareholder and
executive and director interests, from a number of perspectives. First, executives
and directors now become large shareholders (as opposed to stock-option-flipping
speculators) in the business. Moreover, by restricting the sale of the stock for a very
long time, these individuals now become more concerned with long-term company
performance. In addition, by adding the proviso that the stock can be sold at any
time if the company is purchased, these individuals may now also be less averse to
a takeover bid for the company.

STRONGER INDEPENDENT OUTSIDE BOARDS OF DIRECTORS. Hypothetically, a com-
pany’s board of directors supervises and monitors the company’s CEO, preventing
her or him from empire building and making sure that takeover bids and other

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