Safety Suffers as Stock Options Propel Executive Pay Packages

Author: Gretchen Morgenson

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Outsize executive pay packages have frequently been a flash point for stock market investors. Lavish executive compensation at publicly traded companies should be a significant concern for consumers, too.

That’s the message of a new study by three academics at the University of Notre Dame. Their research focuses on companies that rely heavily on stock options in executive compensation. They have found a correlation between generous option grants and the incidence of serious product recalls.

Stock options have been the jet fuel propelling some of the biggest executive pay packages over the years. From an investor’s point of view, these instruments are problematic because they provide an executive with little downside if the company’s underlying shares fall but oodles of upside on the rise.

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This heads-I-win, tails-I-barely-lose arrangement encourages executives to swing for the fences, an array of academic research has shown. Eager to reap the riches from a rising share price, option-laden executives have been found to make unwise acquisitions or, even worse, to undertake aggressive accounting practices.

Now comes evidence that product recalls are often linked to abundant option grants handed to chief executives. The study, “Throwing Caution to the Wind: The Effect of C.E.O. Stock Option Pay on the Incidence of Product Safety Problems,” concluded that “C.E.O. option pay was associated with both a higher likelihood of experiencing a recall as well as a higher number of recalls.”

The study’s authors are Adam J. Wowak, Michael J. Mannor and Kaitlin D. Wowak, all assistant professors of management at the Notre Dame Mendoza College of Business.

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In an interview on Tuesday, Mr. Wowak said that he and his colleagues wanted to build on past analyses of how stock options induce risk-taking among executives. “If options are generally causing C.E.O.s to be more aggressive, then it makes sense that more mistakes could occur and consumers could be affected,” Mr. Wowak said. “Options could be making C.E.O.s ignore the downside potential of some of their actions.”

Read the entire interview on the New York Times website.