The most pronounced change in corporate compensation practices over the past decade is the escalation and recent decline in executive and employee stock options. In 1992, firms in the Standard & Poor's 500 granted their employees options worth a total of $11 billion at the time of grant; by 2000, option grants in S&P 500 firms increased to $119 billion. In 2002, option grants in the S&P 500 fell to $71 billion, well below their peak, but still a six-fold increase from a decade earlier. Despite―or perhaps because of―their growing importance, employee stock options have become increasingly controversial. The main argument in favor of stock option plans is that they give executives a greater incentive to act in the interests of shareholders by providing a direct link between realized compensation and company stock price performance. In addition, offering employee stock options in lieu of cash compensation allows companies to attract highly motivated and entrepreneurial employees and also lets companies obtain employment services without (directly) expending cash. Options are typically structured so that only employees who remain with the firm can benefit from them, thus also providing retention incentives. Finally, stock options encourage executive risk taking, which can mitigate problems with executive risk aversion. But the incentives provided by stock options have also been criticized. The recent accounting scandals at Enron, WorldCom, Global Crossing and other companics have been linked to excessive risk taking and an excessive fixation on stock prices, both allegedly caused by the escalation in option grants (Cassidy, 2002; Madrick, 2003). Moreover, these scandals have focused attention on problems with current accounting practices, which in turn has opened a debate on the accounting treatment of employee stock options. Under current U.S. accounting rules, companies generally do not treat options as an expense on company financial statements. Proponents of expensing options argue that expensing will generate more informative financial statements and improve the credibility of reported earnings. Opponents of expensing worry that expensing will cause companies to grant fewer options, especially to lower-level employees, which in turn will "destroy the engine that fueled the economic growth" of the 1990s.
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