Well, the biggest pro is that CEOs only make lots of money if the stock price is way higher than when the option was granted - and a higher stock price is good for the shareholders as well. The problem is that CEOs sometimes make decisions that provide a short-term boost for the stock, but are not always in the long-term interests of the company. Also, a look at the local companies on the new Fortune 500 list. Available at kpcc.org and podcast (Business Update with Mark Lacter).
Steve Julian: Mark, we were talking yesterday about highly-paid college presidents in Southern California. Let's talk about the highest-paid CEOs - and there's a local name on top.
Mark Lacter: His name is Michael Johnson, he's chief executive of L.A.-based Herbalife, the maker of those nutritional supplements - and last year his total pay was almost $90 million, which is believed to be the highest compensation for a U.S. executive in 2011. (Not all companies have reported their numbers, so it's possible another CEO might beat Johnson, but clearly he's at the top end.) And the reason he's at the top end is that of the $90 million, $77 million is the result of Johnson exercising his stock options late last year.
Julian: Nothing wrong with that.
Lacter: No, it's perfectly fine for a company granting stock options to senior executives. It's a time-tested way to attract talented people. Tech startups do it all the time. The way it works in basic terms is that companies will grant the employee a stock option at a certain price - let's say $10 a share. The employee will then be able to exercise the option at some future date and convert it to stock - presumably at a point when the price is a lot higher.In the case of Michael Johnson, most of the stock options were granted by Herbalife between 2003 and 2005, which is when he was new to the company - and the stock was trading at eight or nine bucks a share.
Julian: And when he sold?
Lacter: By late last year, the stock was trading at around $60 a share. So he obviously did very well, though so did Herbalife shareholders. And that's why stock options can be such a powerful incentive: If the company does well, then the CEO does well. The problem is that CEOs will sometimes make decisions that provide a short-term boost in the stock price, but not always be in the long-term interests of the company. And sometimes CEOs will arrange their compensation deals so they'll always make good money, even when the stock is not doing well. And that's when shareholders tend to get upset.
Julian: Funny thing is, Herbalife isn't that big company - didn't even make the Fortune 500.
Lacter: Quite a ways off, Steve - but then again, not many local corporations made the list. Just 19 of the Fortune 500 are based in Southern California - and only four of those are in the city of L.A. The largest locally-based company on the Fortune list is Disney, which has its headquarters in Burbank. It's at number 66. (Exxon Mobil is tops on the list.)
Julian: LA never really had a lot of BIG corporations, did it?
Lacter: No, it never did. New York, Chicago, and even San Francisco are considered more corporate towns, and if anything the numbers have gotten smaller over the years, what with mergers and relocations. Keep in mind, though, that just because big companies aren't headquartered here doesn't mean that they're not coming here. Good example is Target, which ranks number 38 on the Fortune list. It employs roughly 15,000 people in L.A. County, and they'll be hiring even more folks when Target opens several additional stores (downtown among them).