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Stock Strategist

Stock Options Aren't Ownership

Options offer managers a chance to cash in, not a stake in the firm.

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One of my favorite scenes in the movie Wall Street takes place when the character Gordon Gekko preaches to the shareholders of Teldar Paper about the lack of ownership among management in corporate America. "In the days of the free market when our country was a top industrial power, there was accountability to the stockholder," gripes Gekko. "The Carnegies, the Mellons, the men that built this great industrial empire, made sure of it because it was their money at stake. Today, management has no stake in the company!" Sadly, Gekko's comments remain true today.

It's important for management to own a stake in the companies they help run because it aligns their interests with shareholders. The best management teams think of shareholders as partners, and consequently only make (or lose) money when everyone does. You can find lots of information about management ownership in annual proxy statements that firms file with the Securities and Exchange Commission. There's typically a table at the beginning of the report that says how much management, directors, and major stockholders (i.e. over 5% of the firm) each own.

However, if you look closely at the footnotes, management ownership is oftentimes grossly overstated by the options they've been given by the board of directors. The SEC counts options exercisable within 60 days of a particular date prior to the time the proxy was filed as ownership. The problem is that owning options isn't the same as owning the stock. Management hasn't paid anything for the options, so they don't have the same risk as shareholders that have actually spent cash. If the company does something dim-witted and the stock price plummets, shareholders are the only ones that ultimately lose money; meanwhile, management's potential loss is capped at zero, but upside is unlimited. Management can even issue a new set of options at a lower price--or reprice existing ones and start the process over.

Mike Trigg does not own shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.

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