What is a CEO? CEO is an acronym for Chief Executive Officer. What is a stock option? Well, we will get to that. And we will also delve into how guys just like you and me, well, not me so much, go to work every day to make millions and maybe even billions for high-level executives and CEO’s. Why do CEO stock options end up cutting into your retirement or investment returns? I can’t resist. “They thought they were free.”
I am not kidding. Highly educated long-tenured financial professionals from the Nation’s top schools really thought that they could create crazy bonuses and compensation programs for executives and CEO’s out of the fiscal thin air. Like we live in Pokemon world or something. As it turns out, CEO stock options are not free. They cost the investor. Guys just like you.
Why Have CEO Stock Options?
Here we go. What is a CEO stock option and why do CEO’s and other executives get stock options in their compensation packages? Imagine you end up running a large multi-national company with an annual revenue of a couple of hundred million dollars. Now imagine that your annual compensation is $2,000,000.00.
Now, to play devil’s advocate, let’s say that you take your job and your salary seriously and that rather than work 40 hours a week, you work 75 hours a week. After all, you don’t earn big promotions and multi-million dollar salaries by punching in late and going home early; you are that first-in-last to go home kind of boss.
For the sake of easy math and your CEO sanity, let’s say you take two whole weeks of vacation, so you work 50 weeks averaging 75 hours a week for a total of 3750 hours. Now, divide 3750 hours into$2,000,000.00. Your simple arithmetic will reveal a nominal hourly rate of pay of $533.33 an hour. While one can definitely live on $500 an hour, is that really big time CEO pay? What about after taxes?
Unless you have offshore tax-dodging accounts set up in the Cayman’s (which your CEO friends keep telling you to look into) you are probably closer to $300 an hour or even less by the time you deduct out Uncle Sam’s cut. Something has to be done here, or you will go broke at only $285 an hour… CEO stock options maybe?
How CEO Stock Options Got Their Start.
Believe it or not, CEO stock options got their start back in 1993 or so. At this time, CEO pay was exploding or beginning to explode, actually. Tax laws said that a company could deduct all of the pay of the CEO and other top executives at 100%. In a way, paying a CEO a high salary could be beneficial to the bookkeeping.
Politicians in general, and then pre-President Bill Clinton in particular, rallied against this practice in order to curb the ballooning pay packages that CEO’s of the nation’s largest corporations were compensated with. Clinton wanted a change, Clinton proposed capping the deduction for CEO pay at $1,000,000.00. Clinton proposed tying CEO pay to the actual performance of the company. If you wanted to pay your CEO more than $1,000,000 then you could, and that compensation could be deducted at 100%, as long as that pay is clearly tied to performance.
Bookkeepers and bean counters began scurrying to find a way to incorporate coming changes into their tax structures and voila – we started to get a huge rise in payments through stock options. Almost overnight. With no real understanding of how or what the consequences of CEO stock options would or could be.
How Do CEO Stock Options Work? Here Is A Quick Example.
So imagine that while you are CEO, the company board of directors comes to you and says that they want to cut your base pay in half, to $1,000,000.00 and give you stock options. A stock option works like this:
Say when you began as CEO, the price of one share of stock in the company was $100.00. By the time you were done with your first year of 75 hour work weeks, the stock price had risen to $110. If you had an annual stock option, you would then be allowed to purchase a share of stock for $100, and then immediately sell it for $110, pocketing $10.
If however, the stock price of the company dropped on your watch, a stock option to purchase a share of stock at $100, when the current price of the stock is $90, would do you no good at all. This is how CEO stock options are tied to CEO performance, and why CEO stock options are therefore 100% deductible.
However, in order to put CEO stock options in perspective, we have to start using much larger numbers, after all, if the board wants to cut your salary by 50%, they are going to have to do a lot better than a possible $10 stock option bonus at the end of the year, right?
How CEO Stock Options Played Out In Reality.
In the continuing saga of you as CEO, let’s say you set a meeting with the board of directors. You point out your current $2,000,000 salary, your 75 hours a week work ethic, and the increased profitability of the company under your watch, which has been quite significant and numbers in the tens of millions of dollars.
Your keen mind for CEO numbers points out that the tax savings the company would reap by cutting $1,000,000 of your base salary are quite minimal in comparison to the financial gains accrued under your watch. Bottom line: you won’t CEO their company for $140 an hour, and they can’t find a good, proven CEO for $140 an hour and they know it. You will keep your $2,000,000.00 AND you want those CEO stock option bonus packages they wanted to give you instead of salary. You drive a tough bargain, but that is exactly what they hired you to do.
We can look back and see that this is exactly what happened. Base CEO pay really did not drop, but CEO compensation essentially exploded. Exploded so much that the AVERAGE CEO pay mushroomed to somewhere around $19,000,000.00 a year. That is about $5066.66 an hour for a 75 hour work week or $10,326 an hour if you take a more CEO like 6 weeks of vacation and phone in a chill 40 hours a week.
Perhaps those numbers will begin to put enough to put owning gold into perspective for you. Gold does not have a CEO to pay or CEO stock options that need granted and paid for. Owning gold is an attractive way to increase the actual percentage of your investment dollars that get invested, rather than bonus-ed to CEO’s as CEO stock options, ITM Trading makes owning gold easy.
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Chief Market Analyst, ITM Trading