Executive compensation in the form of stock options is a formula that has contributed to the dramatic increase in the overall compensation of executives. Stock options give holders the right to purchase shares at a predetermined price, but they may be exercised only after a waiting period. The amount of compensation thus obtained is equal to the difference between the exercise price agreed upon and the share price at the time the options are exercised. By giving executives stock options, corporations try to align their interests with those of the shareholders and to retain them.
In this type of compensation formula, the basic premise is that market price increases are due to the decisions made by senior management. Research has shown that the stock market performance of organizations is influenced by a large number of factors that are beyond the control of senior management, such as interest rates or inflation. For example, Professor Magnan conducted research that shows that, between 1998 and 2008, 90% of the changes in the stock market prices of the five large Canadian banks were due to characteristics of the banking sector, such as low interest rates and a favourable economic environment. One should therefore refrain from linking the exercise of stock options solely to the market prices trends.
In order for this portion of the variable compensation package to achieve its objectives and take into account factors over which senior management may have an impact, we propose that these stock options may be exercised, after the waiting period, only to the extent that measurable and quantifiable objectives have been achieved, such as higher earnings per share, return on shareholder equity or other non-financial indicators the compensation committee may deem relevant.