Betting, Point Spread and CEO’s Stock Options Plan

Rakesh Khurana, a management thinker, has written book on how companies behave irrationally when they hunt for CEOs. The expectations from new CEO, his salary package, and reaction of stakeholders/ stock market to new CEO are anything but normal.

“The image of a CEO changed from being a capable administrator to a leader—a motivating, flamboyant leader with a new task… it was no longer about the profane task of making money, but concerned with vision, values, mission—essentially religious terms.”
-Rakesh Khurana

One of the major components of salary package is stock options, the CEO is supposed to perform each quarter, use his charismatic power to improve performance of company, thereby increase share price and benefit shareholders. Due to stock options he also makes money if share price rises.

Another management thinker Roger Martin has written a book called “Fixing the Game”. Here using analogy of National Football League of US, he talks about two markets- Real Market and Expectations Market.

Real market is where action is i.e. players practice a lot, play game, exhibit their talent , the crowd enjoys the game, broadcasting companies show matches on TV etc. This market generates revenue from tickets spectators buy, broadcasting rights, advertisements etc.
While the real game is being played another market is also active- the market of betting. Oddmakers are busy deciding point spread, people are placing bets, some win and many lose. This is market of expectations.

The point spread system works like this…
Let’s say there are 2 teams Team A and Team B. Team A, being a stronger team is likely to win, so everyone will bet on A, but to make betting process more interesting and make people bet on Team B, the odd makers have devised what is called as point spread system.

The point spread is the head start that oddsmakers give to the underdog. Betting against the spread can make a lopsided event more interesting – rather than just winning outright, the point spread is designed to make betting on either side equally attractive.
Based on various factors ( team performance, key players etc.) oddmakers decide to give Team B a head start of 3.5 points ( denoted by + sign), it is denoted as
Team B + 3.5 & Team A -3.5
With the spread set at 3.5 points, if you bet on the Team A, you’ll win your bet if they win the game by more than four points (or if their score is higher even after you subtract 3.5 points from it). If you bet on the Team B, you’ll win your bet if they lose by no more than three points.

Problem with expectation market is with each win the spread keeps increasing, soon it becomes so high, even if they win by reasonable gap, due to high point spread those who have bet on them will still lose.

“The lesson is that no matter how good you are, you cannot beat expectations forever. Expectations will get ahead of you.”
-Roger Martin

 

cartoon1[1]

If players start focusing on expectation market instead of real market , then the game will suffer ( ex.IPL matches the focus has shifted from real game to match fixing, betting, bookies, disgraced players like Srisanth etc.)

In corporate world, the real market is the world in which factories are built, products are designed and produced, real products and services are bought and sold, revenues are earned, expenses are paid and real profit show up on the bottom line.

The expectations market is the world in which shares in companies are traded between investors,in other words, the stock market.

lee-lorenz-hold-it-we-almost-forgot-your-backdated-stock-options-new-yorker-cartoon[1]

Since salary of CEO is tied to stock options, he starts focusing on expectations market than on real market.

“If the CEO can double the price of the stock by the time he retires, he will have earned $18 million in that year rather than $10 million. No wonder, then, that our executives focus almost entirely on the expectations game. They do so at the cost of turning their attention from the real game, from real customers and from real value.”
-Roger Martin

This short term strategy ruins the real market in long term as CEO is more interested in share price rather than concentrating on designing innovative products, improving processes and making company profitable.

overpaid-ceo[1]

Time has now come to review divine status of CEO, his astronomical salary and stock options.

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