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Golden handcuffs are off

Thanks to soaring stocks…

Duncan Mavin
The National Post
October 26, 2005

Stock options are meant to serve as so-called golden handcuffs that bind top-notch executive talent to the firms they serve. But this retention strategy appears to be backfiring in the oilpatch, where stocks are soaring.

Roughly 40% of the total compensation for “C-level” senior managers — chief executive, chief financial and chief operating officers — is usually in the form of a long-term incentive plan, often stock options.

In the booming oilpatch, the value of those options has taken off, which should be good news for all investors, including option-holders. However, it presents a dilemma for C-level managers, many of whom are closing in on retirement age at the same time as their investment portfolios become increasingly imbalanced and weighted toward the success of their employer’s stock.

Executives often want to cash in the profits on their options, but are concerned that if they do, they may send inappropriate signals to the market concerning the health of the company they work for, or else fall foul of increasingly stringent governance measures which puts the personal investment decisions of individual executives under the microscope.

“When you’ve got $2-million in options on the table and a CEO worried about compliance, Sarbanes-Oxley, and what the board’s going to think, sometimes it’s easier just to walk away from the organization, take out your gains, and reload your options with a new employer who will often compensate you for the unvested options you are walking away from as well,”.

The stock option conundrum may affect as many as one-fifth to one-third of the companies in Canada, across all sectors of the economy. But it’s especially problematic for oil companies because the value of options rise dramatically over short periods.

“You saw it a little bit in the high-tech days, too,” Mr. Hall says. “But that was fairly short-lived whereas in the oilpatch it’s been over a longer period.”

To solve the problem, Mr. Hall says, companies must send a clear message of support for senior managers who exercise their options in order to deal with the stigma among the investing community.

Firms should also investigate other options such as introducing more sophisticated compensation plans to help retain top talent and protect shareholder value.

“Companies are getting a lot smarter and a lot more strategic about their long-term compensation,” Mr. Hall says.

Many corporations are dealing with the problem by pushing as many options as possible into the “unvested pool.” Typically, options vest within three to five years, and must be exercised within five to 10 years. But if a greater proportion of executive compensation is deferred until a later date there will be less incentive to walk away early, and rival employers will have to come up with a bigger up-front package to entice executives to do so.

Companies can also vary the structure of the compensation being offered. That could mean introducing deferred share units or restricted share units, which typically tie employees’ compensation to the success of their employer for a longer period than traditional stock options.

Sophisticated candidates for senior management positions also have a firm grasp of the growing range of possible compensation vehicles. “A couple of C-level individuals I can recall — you should have seen the smile on their faces, not just because of the position they were walking into — but the cash-out they were able to secure [when they left],” Mr. Hall says.