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Stock option plans can be effective tools in moderation

Setting "appropriate" compensation -- meaning remuneration that truly aligns the interests of management and shareholders -- is one of the most important tasks for directors of public companies.

Unfortunately, over the last decade, greed mixed with a 'we're only doing what every other company does' attitude has led to compensation schemes that have instead enriched executives. In some egregious cases, these schemes have robbed shareholders of billions of dollars of value.

For this reason, institutional investors have been fighting hard for appropriate compensation tied to performance criteria, while actively promoting the need for proper accounting and governance rules to protect shareholders' interests.

The beachhead for much of our work is stock option plans. We are not totally against stock options; used in moderation, options can be an effective tool.

Some of the features we like to see in option plans include:

performance vesting

indexed exercise prices

following exercise, requiring management to keep at least 40 per cent of the shares acquired until they retire.

But we are opposed to plans that:

have a "burn rate" -- the number of options granted in a given year expressed as a percentage of total outstanding shares -- that is more than 1 per cent a year;

vest immediately instead of over the life of the options, and have a life of five years or more;

allow directors to reprice or otherwise change the terms of the options;

concentrate 25 per cent or more of the options granted to one single individual;

are not expensed on a company's income statement, since options represent a fair drain on profits for existing shareholders.

Without such accounting, it's impossible for many Canadian retail investors to get an accurate picture of corporate earnings, which is a critical determinant of share value.

Fundamentally, we are also opposed to compensation that is not tied to meaningful performance hurdles.

We don't believe our criteria for voting in favour of option plans are unreasonable. Yet, over the past few years, we have been forced to vote against 70 per cent of the plans presented to us.

By working with the Canadian Coalition for Good Governance, we hope that our representatives -- the directors of public companies -- will listen more attentively to our message.

Our long-term interests as shareholders and the interests of management must be aligned. But in too many option plans today, sadly, this is not the case. Many of the plans are more like lotteries.

© The Globe and Mail

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