Executive Stock Options Correlate With Higher Fraud Rates


New research shows that when companies with historically mediocre performance meet executives with lots of stock based compensation, the situation is ripe for fraud.

"Millions and sometimes tens of millions of dollars worth of CEO compensation ride on these stock options," explained Prof. Bromiley. "That's enough to motivate some executives to deliberately fudge the books so that stock prices go up."

The authors found bonuses had little influence on misrepresentation. "Unlike with stock options," they write, "we found no significant influence of bonuses on financial misrepresentation." They note that options and bonuses offer different incentives and that options offer massively greater financial returns to CEO's than bonuses do.

It's interesting that Warren Buffett is so admired in financial circles, has warned Wall Street about the dangers of stock based executive compensation, and still gets ignored.

Berkshire employs many different incentive arrangements, with their terms depending on such elements as the economic potential or capital intensity of a CEO's business. Whatever the compensation arrangement, though, I try to keep it both simple and fair.

When we use incentives – and these can be large – they are always tied to the operating results for which a given CEO has authority. We issue no lottery tickets that carry payoffs unrelated to business performance. If a CEO bats .300, he gets paid for being a .300 hitter, even if circumstances outside of his control cause Berkshire to perform poorly. And if he bats .150, he doesn't get a payoff just because the successes of others have enabled Berkshire to prosper mightily. An example: We now own $61 billion of equities at Berkshire, whose value can easily rise or fall by 10% in a given year. Why in the world should the pay of our operating executives be affected by such $6 billion swings, however important the gain or loss may be for shareholders?

As I wrote previously, CEO pay is Lake Wobegon run amok.

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