It is a common corporate practice to supplement the already large salaries paid to the heads of companies and other employees with stock options, or other forms of remuneration that are based on the company’s stock price. However, there are a number of reasons why this practice should be prohibited.
First, executives know very well that their actions, decisions, and declarations can affect their company’s stock price. Considering how much money they can make by exercising their stock options at a low price, as stipulated in their contract, and then selling the shares at a higher price – in some cases more than $100 million in a single year, this gives them a strong incentive to be dishonest about their company’s financial performance. That this is not an abstract or merely theoretical concern was shown by the spate of scandals perpetrated by the executives of a number of American companies in the 2000s. If executives and their close relatives were not allowed to own shares of the company for which they work, then they would have less incentive to use duplicitous means to maintain or increase the company’s stock price.
Second, the identification by the company’s executives with the company’s shareholders sometimes creates a conflict of interest. It is assumed by economists and others that these two interests – what is in the best interest of the company and what is in the best interest of the shareholders – are always the same. But there are instances where this belief is wrong. An example is stock buybacks, where a company buys back some of its own stock in order to reduce the number of outstanding shares and, presumably, increase its stock price. Although this expense, which can cost the company billions and billions of dollars, may benefit the shareholders, it does not benefit the company in any way. Money that could have been used to do research, develop new products, hire new employees, pay its debts, expand its operations, or pay their current employees better wages is instead wasted in this frivolous manner. As this example shows, the identification with the company’s shareholders can lead the executives to make decisions that benefit the company in the short term, while they neglect the company’s long-term interests.
Third, such large financial remunerations reduce the motivation for executives to continue working. Most executive positions are high-stress and high-pressure jobs that take up a lot of the executives’ time. Hence, if they are able to make tens or even hundreds of millions of dollars in just a few years, then they will have less motivation to continue working. To those who advance the well-worn argument that these large financial compensations and bonuses are necessary in order to attract the best talent and the most capable individuals, I reply that, apart from the corporate sector, where else could these executives earn as much money as they do, even without the large bonuses from stock options that many of them presently receive? To say that executives need stock bonuses to motivate them is short-term thinking of the worst kind. For when they leave the company, most executives will work for another company. Unless they are about to retire, executives therefore have a strong motivation to do their best because an underperforming executive is less likely to be hired by another company and be well-paid by it. If their financial remuneration were strictly limited to the salary paid by their company, then they would have a stronger motive to do a good job, regardless of whether they continue to work for the same company or for another company in the future.
Since the large salaries that are paid to corporate executives have been compared to the large salaries that are paid to entertainers, actors, and professional athletes who are the best in their fields, it is useful to consider the situation in professional sports. In the case of managers and athletes of professional teams, they are paid only a salary for their efforts and achievements. Neither of them receives a share of the profits that are earned by the company, group, or individual that owns the team, even though they contribute, by their actions and decisions, to the size of those profits. Moreover, they are not given a part ownership of the team as part of their contract, in cases where the team is publicly-owned. And yet, I doubt there is anyone who would argue that managers and players of professional teams are less motivated to do their best because of this lack of ownership or a share in the team’s profits. In my opinion, this is how financial compensation should be structured in the corporate world. In other words, there should be a strict separation between corporate control and ownership of the company, since the merging of these two elements can sometimes lead to abuses of corporate power.
The one exception to this proposal is what I will call the founder’s exemption: as its name suggests, a founder of a company may be allowed to own its shares while retaining executive control over it, even after the company has sold shares of its stock to the public. This is because a person who founds a company is more likely to care about its long-term success. There will inevitably arise exceptions to this belief, but in most cases I believe that those who found a company are more likely to care about it than those executives who are merely hired to operate it for a number of years, after which they often have no further association with the company.
It is assumed that owning a part of the company for which one works will increase one’s motivation to do everything possible to ensure its success, both in the near and distant future. While this may have been true in the past, there are several changes that have made this assumption less valid in today’s world. First, the average length of tenure of chief executives has declined considerably in recent decades. At present, the typical chief executive in the United States spends just under five years at a corporation – hardly long enough to develop a strong attachment to and identification with the company and its long-term success. In the past, both executives and workers stayed with a single company during most of their working lives, which created a very strong sense of loyalty, a loyalty that no longer exists in today’s frenetic world of rapid change, where human beings are increasingly regarded as disposable parts of the companies they work for. Second, the stock market is more volatile now than it was in the past, in part because many people no longer buy a company’s stock with the intention of holding it for a long period of time, while relying on the dividends paid regularly by the company, as was formerly the case with many stock owners. In such a volatile financial environment, executives are more likely to sell their shares when the price is high rather than hold onto them for a long period of time. Hence, for them, owning shares of the company they work for is merely a way to earn extra money, in some cases more than their annual salary, rather than being a guarantee of company loyalty.
The awarding of stock options to a company’s executives is an example of how unbridled competition can produce an outcome that, in many ways, is neither optimal nor desirable. Once one company decided to give stock options as part of their executives’ compensation, other companies imitated them, until all large companies were obliged to do likewise in order to compete for the best executives. Then there developed a competition among companies to award the most stock options to their executives. It is only in this sense that companies must offer stock options as part of their executives’ compensation, since they are forced to compete with each other to get the best individuals to work for them. But if all companies were prohibited from engaging in this practice, then there would be no need for any company to offer stock options to its executives.
Second, even to the extent that corporate boards correctly judge both the quality of executives and the extent to which quality matters for profitability, the actual amount they end up paying their top executives depends a lot on what other companies do. Thus, in the corporate world of the 1960s and 1970s, companies rarely paid eye-popping salaries to perceived management superstars. In fact companies tended to see huge paychecks at the top as a possible source of reduced team spirit, as well as a potential source of labor problems. In that environment even a corporate board that did believe that hiring star executives was the way to go didn’t have to offer exorbitant pay to attract those stars. But today executive pay in the millions or tens of millions is the norm. And even corporate boards that aren’t smitten with the notion of superstar leadership end up paying high salaries, partly to attract executives whom they consider adequate, partly because the financial markets will be suspicious of a company whose CEO isn’t lavishly paid.
In the early 1990s, options had accounted for less than a quarter of executive pay. But by 2001, some 80 percent of executive compensation was in the form of stock options, notes [Arthur] Levitt, who looks back with regret on his role in failing to stop their explosive growth. “I consider this my biggest mistake as SEC chairman.”
This is an example of a foolish practice that has become widespread due to our strong human tendencies to imitate and conform to the behaviour of others. It also illustrates the important but frequently unrecognized fact that, left to itself, the free market does not always produce the best, or even a beneficial, outcome, since the decision to award corporate executives stock options was an entirely free-market decision.
A related but slightly different matter is the need to separate corporate power from all the branches of government power – legislative, executive, and judicial. Because the rise of corporate power only took place after the U.S. Constitution was adopted, it is hardly surprising that its formulators completely failed to recognize the importance of separating corporate power from the three branches of the American government. The failure to check corporate power, influence, and excess is the greatest problem facing the American people today. The fact that Americans have visibly failed to prevent corporate power and control from assuming a disproportionate influence in government and legal matters is the primary reason why their democracy is no longer a “government of the people, by the people, for the people”, but is instead a “government of the corporations, by the corporations, for the rich people.”
 Whereas, apart from the payment that was made by the original purchasers for their shares, a company’s shareholders have contributed absolutely nothing to the company which they own, the company’s workers obviously do contribute significantly to the company’s success. And yet, in the corporate system that we humans have devised and adopted on a large scale, it is the shareholders whose views and concerns are addressed, while increasingly the workers’ views and concerns are ignored because they have little or no power and influence on the decisions that are made by their company’s autocratic rulers. Clearly there is something wrong with such a perverse and unjust system, which rewards those who contribute little, while it occasionally mistreats, oppresses, overworks, and callously dismisses those who contribute significantly to the company’s success.
 The Conscience of a Liberal by Paul Krugman, p. 144. W. W. Norton & Company, New York, 2007.
 Billionaires’ Ball: Gluttony and Hubris in an Age of Epic Inequality by Linda McQuaig and Neil Brooks, chapter 7. Beacon Press, Boston, 2012.