Directors Share Options

Introduction to Directors' Share Options

One way in which long-term performance can be rewarded is through the granting of directors' share options. This sort of reward though has provoked considerable controversy.

For years a debate has raged over whether granting share options to directors is consistent with good corporate governance. Peter Drucker, an eminent management thinker, has been a vociferous critic of this way and has considered to it as 'an encouragement to loot the corporation'. We shall now refer the major features of directors' share options and then go on to explore the case for and against using options to reward directors. We shall observe that a company implementing a share option scheme of directors must grapple with a variety of issues and problems.

What are directors' share options?

A directors' share option scheme gives directors the right, but not the obligation, to buy equity shares in their company at an agreed price. The conditions of the scheme will usually stipulate that the option to buy must be exercised either on, or after, a specified future date. A final date for exercising the option will also usually be specified. Share options are normally awarded only to executive directors. The UK Corporate Governance Code states that non-executive directors should not be rewarded in this way.

Directors' share options will only be exercised if the market value of the shares exceeds the option price. Where the option is exercised, the company must issue the agreed number of shares to the director that will make a profit from the transaction.

The option differs from most financial options in that a director will not normally be required to pay for the option rights: they are granted at no cost to the directors concerned. Directors' share options, however, cannot be traded and will usually be forfeited if the person leaves the company before the option can be exercised.

In the UK, directors' share options are normally issued at the current market price of the underlying shares. In the past, share options were occasionally issued at a discount to the market price; though, the UK (United Kingdom) Corporate Governance Code has discouraged this practice. The terms of a share option scheme often allow the directors to exercise their option no earlier than 3 years, but no later than 10 years, after the choice has been granted. Inland Revenue rules and best practice guidelines from institutional investors limit the value of options to £100,000 or four times current salary. The exercise of the option might be matter to certain performance targets, such as growth in earnings per share, being met.

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