The Real Economy

Options manipulation ruining corporate performance - a note

Hector McNeill¹
SEEL

The creation of options as a way to provide executives and managers with an incentive to improve corporate performance, has, under quantitative easing had the reverse effect, leading to depressed wages and productivity.

This is the result of a manipulation by executives to gain significant income boosts and share price quotations, at the expense of corporate prospects.

Share options

Share options are contractual agreements handed to executives as part of their payment portfolios. Share options provide the executives with the "option" of purchasing their company shares at a fixed future price. If share values have increased above that price then the executives make a profit in assets holding by keeping the shares or cash income by selling them.

The shaky theory justifying this system of recompense is that if executives take actions to increase the share price they are advancing the performance of the company and its future prospects. So the theory runs, the executives therefore have a strong incentive to take actions that improve company performance to everyone's benefit.

Options manipulation

With the advent of quantitative easing and the lax financial regulations, companies can buy back their own shares using very low interest loans from willing banks. This results in a false share buying signal that encourages the market to follow suit, driving the share price even higher. The unsavoury aspect to this ramping up of share prices is that it is not based on any technical, productivity or investment and market prospects analysis, the focus remains on share price. This type of market manipulation should, of course, be illegal, because it leads to wholly misleading market signals and rises in share prices that have no fundamental justification. However, this manipulation helps executives lift the share prices sometimes well beyond their option price so as to land them with a massive asset or cash benefit.

It is estimated that something like 50% of the rise in share prices during the last 7 years has been the result of share buy backs by companies.

Shareholder value

Shareholder value used to be related to net profits and dividends paid to shareholders. However, the relationship between share prices and dividends has in many cases collapsed with share holders focusing on the sales value of the shares they hold. As a result share holding has transitioned into a less meaningful and permanent affair of supporting a profitable company in a sector deemed worthy of support. This has resulted in increasing number of shareholders not questioning share options for executives because the outcome, while being destructive to company prospects has increased the sales value of shares held by shareholders. They can always sell these shares at a handsome profit before the company fails and "reinvest" these proceeds in the next company whose shares will rise as a result of the same tactics. The result is a collaboration between executives and shareholders in the exercise of a parasitic and destructive behaviour with respect to the stability and sustainability of the company and employment of its workforce. However, the workforce has no say in this matter.

Wages and productivity

Needless to say, wages being classified as a cost remain locked under the government revenue-seeking taxation barrier that is applied to profits. The payment of dividends from net profits has been taking second place to significant gains in share values unrelated to profits or productivity gains resulting from investment. Wages and productivity stagnate while executives on stock options gain massive boosts to their income unrelated to company performance or the wellbeing of those employed.

Investment to create prosperity and employment?

There has been much talk about the importance of higher income individuals being creators of emploment through their investments and that such activities create prosperity from which all benefit. However, we witness in the context of the subject of this note, quite the reverse. It would seem that such people should not be rewarded yet more through income tax reductions and other gifts from government when the behaviour of some is patently destructive to the prospcts of sustained employment with decent wages. This form of "investment" has reduced share certificates to the equivalent of playing cards in a card game whose outcome is fixed by executives on share options.

Consequences

In many cases, this process is based on raising excessive levels of corporate debt, weakening the financial status and risk associated with corporate activities. Today, executives are highly mobile and seldom stick around to become accountable for failures resulting directly from their decision-making which is often dominated by personal financial interests and not the interests of the company that currently employs them. This process is in essence a form of asset and cash flow stripping, openly exercised by executives that in several high profile cases led to corporate failure and loss of employment for those who have had to endure a long period of stagnant wages. This behaviour is destabilizing to the economy and the practice needs to be reviewed from the standpoint of introducing legislation and regulations to make share options and corporate share buy backs illegal. This could provide larger corporations with an incentive to employ executives whose competence is less about a parasitic sole pre-occupation with their personal financial gain and more orientated towards managers whose competence involves a sound grasp of the technical and human resources issues that can lead to better decisions to enhance the sustainability and performance of the company.

What is stated in this note is not particularly revealing, these are known facts. What is revealing, however, is the inaction by government, parliament and financial regulatory agencies, so-called, failure to act to terminate this economically and financially destructive corruption.

¹ Hector McNeill is the director of SEEL-Systems Engineering Economics Lab.