Unexercised CEO Options Exploding in Value

A Watson Wyatt news release said its study found that the median in-the-money value of unexercised stock options for CEOs at higher-performing companies more than tripled last year, from $13.8 million in 2005 to $42.6 million in 2006.

Meanwhile, chief executives at lower-performing firms experienced a 5% increase, from $19.7 million in 2005 to $20.6 million last year, according to the announcement.   Company performance is based on total returns to shareholders (TRS); at higher-performing companies, TRS averaged 25% last year, compared with 7% at lower-performing firms.

Overall, the median in-the-money value of unexercised stock options for all CEOs increased 47%, to $28 million in 2006.   The total net increase for the CEOs was nearly $2 billion.  

“Given the stock market’s strong performance last year, it is not surprising that the unrealized gains on stock options soared, especially for CEOs at the best-performing companies,” said Ira Kay, global director of compensation consulting at Watson Wyatt, in the news release.   “While the appropriate level of executive rewards is open to debate, it is clear that the greatest gains are going to those whose companies are performing best.   This shows that the pay-for-performance model is working at most companies.”

The in-the-money value for executives at higher-performing companies grew substantially last year because stock options are highly leveraged and a strong increase in shareholder returns can lead to an even larger increase in option value, noted Kay.

“This year’s proxy season should show another year where pay levels reflect strong corporate performance,” Kay said.   “In addition, with new executive pay disclosure rules taking effect, we will likely see a number of changes to executive pay programs as companies continue to try to motivate and engage executives while ensuring that the link between pay and performance satisfies shareholders.”