Better Options

Most experts believe that if executives treated restricted stock the way they have treated stock options — that is, sell immediately upon vesting — restricted stock would be an all-around poor substitute for options from both an incentive and a retention standpoint. But anecdotal evidence indicates that executives tend to hold on to restricted stock, even after the restrictions lapse, for longer periods than they do with options.

The reasons for this are obvious. One, most companies that use stock options present them to employees as a substitute for cash compensation, often because a company lacks the cash flow to pay top salaries. Two, options are a poor equity-delivery vehicle. The "cashless exercise" of options delivers the promised cash directly into executive pockets, but in order to exercise options and then retain the resulting stock, a massive cash outlay by the executive is required. The economics of the transaction itself encourages executives to cash out rather than hold.

Conversely, executives may hold restricted stock because to do so costs them little or nothing. Additionally, stock ownership is very good PR with shareholders. About 30 percent of S&P 500 companies require executives to own company stock, according to the corporate-governance research group The Corporate Library. And corporations are increasing those requirements. In addition to a stock-ownership requirement, General Electric recently changed its rules to require senior management to hold stock obtained through exercised options for at least one year.

And even though some recent studies indicate that beneficial ownership of stock by executives is not correlated with positive corporate performance, another study, by Jack Dolmat-Connell, senior vice president at Clark/Bardes Consulting, uncovered a relationship in favor of executive stock ownership. Dolmat-Connell defined beneficial ownership more narrowly (as actual shares held, rather than total of shares held plus options granted) and found an inverse correlation between the ratio of options to stock held and corporate performance. In other words, the higher the number of options versus the number of actual shares held by senior executives, the worse the corporate performance another argument tipping the scales in favor of restricted shares.

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