A number of top corporate executives have opted for smaller salaries and some for no salary at all. The spotlight for this practice recently fell on William Clay Ford, chairman and chief executive officer of the Ford Motor Co. For the year 2002, he received no salary at all.
At first blush, one is tempted to hold up Mr. Ford as an example of a socially minded corporate leader who is ready to make sacrifices for the company he heads during hard times. This action came on the heels of a worrisome report that the company had lost some $800 million in 2002. The Wall Street Journal recently reported that Ford was not alone.
“The company’s four other most highly compensated executives,” an article said, “continued to pass up bonuses and merit raises as the world’s second-largest automaker behind General Motors worked to cut costs and reduce losses.”
Although Mr. Ford received no salary for 2002, he did not end up empty handed. “In lieu of salary,” writes The Wall Street Journal, “Ford received options to purchase 406,247 shares, a package with an imputed value of $1.5 million…. He also received options for 4 million shares with an imputed value of $10.1 million, in lieu of long term compensation.” In effect, Mr. Ford has chosen to surrender a salary in favor of getting stock options. Why?
If he were alone, we would have to look for his peculiar personal reasons. But he is not alone. In both bad times and good, many top corporate executives have consistently given up direct compensation, as in salaries and bonuses, in exchange for stock options. Here’s why: A “stock option” is the right to purchase the company stock at a set price. The move to exercise the option is at the discretion of the holder
For instance, an executive may be granted a million shares allowing him or her to purchase a stock at, let’s say, $50 each. At a given moment, the shares may rise to $75 a share. If the holder of the option sells at that moment, he or she realizes a profit of $25 on a share, or $25 million.
The capital gain is, of course, taxed. But the money gained in this transaction is not taxed at the same rate as would be a salary or bonus. Normally, the top marginal rate in salary and bonus would, at present, be taxed at a relatively high rate. But if it is a capital gain, tax will be less than half that rate. And if the Republicans have their way in Congress, the capital gains tax will be further reduced.
But, you may ask, what if the value of the stock falls rather than rises? In the example we offered above, where the option is to buy at $50 a share, the value of the stock falls to $35. What can the holder of the option do now? He has a simple way to handle his embarrassment. He asks the corporate board to allow him to exercise his option to buy at a reduced price of $15 a share. So, he still realizes a handsome capital gain.
But is such a manipulation of the purchase price legal? So far, apparently it is; precisely such re-evaluations of the purchase price have taken place and continue to take place in many corporations. All of which makes stock options for a corporate big shot worth more than a salary or bonus.