I bumped into an old school mate a few weeks back who has done very well for himself in the high-tech world. He is quite senior in Intel — head of something or other. After a few pints, he began to lament the fall in the share price of the computer giant and its impact on his share options.

By the tone of his voice and his increasing distress, I figured that his paper losses were significant. Although hardly shedding tears, I was moved enough to pay for the next two rounds.

This week, I listened to one of the most esteemed financial commentators in town rounding on the pay deals negotiated in the Programme for Prosperity and Fairness.

He suggested that share options were a much more savvy way of paying employees. The thrust of his argument was that share options link the performance of the company to the performance of the individual and are much more flexible and meaningful than wage deals that impose a huge permanent cost on the firm in the event of a downturn.

He contended that by issuing share options to management and employees, shareholders can ensure that management will do everything it can to drive up the share price, ensuring that shareholders and stock option holders do well in concert.

There is little doubt that management (particularly in the US, where 98 per cent of all S&P 500 companies pay stock options) have done very well out of options. In fact, one of the single biggest forces in widening the wealth gap between management and employees in the US has been the share option scheme.

In 1974, the typical head of a large US corporation earned 35 times more than the average worker. By 1995 that disparity had exploded to 180 times. In Japan and Germany, where the stock option craze is much less pronounced, the corresponding multiples are only 21 and 16.

Even the free market Britain lags way behind the US. The prince of British chief executives, Sam Chisolm of Sky, would be a veritable pauper by US standards. Chisolm netted stg�6.8 million last year, which would put him in 97th place in the US chief executive pay league.

Here in Ireland, the stock option tool is increasingly employed by most quoted companies as a way to attract talent. Managers and executives are routinely poached by rivals who wave generous share option programmes.

In tandem with helping the lucky candidate make up his or her mind, share options appear to keep payroll costs down and are seen as the only way to buy loyalty in a very tight corporate labour market.

Business schools eulogise about this type of performance-related pay and if sceptics decry options as being a bit excessive at times, the answer is usually “get real, don’t be chippy; incentives need to be attractive”.

I am not the chief executive of any quoted company, but I am a shareholder in many, and when I see huge options being given to management as a shareholder I always wonder, who is paying for this largesse and is it making the company more profitable?

The answer to the first question is simple. Shareholders are paying for the luxury of stock options.

A recent article in the Financial Times put the cost of share options in the US at about 20 per cent of total profits across the board. In the high-tech sector, this figure is much higher. Last year, according to the FT, stock options equated to 27 per cent of Oracle ‘s total revenues, not profits. However, in a bull market, when share prices are rising, nobody cares.

The feelgood factor associated with bull markets allows shareholders to ignore the excessive pay packets of executives.

The snag emerges if it becomes apparent that employee stock options have little or no impact on the share price, and the share price subsequently begins to fall.

Let’s go back to my mate at Intel. No matter what he does, he will have no impact on the Intel share price. When Intel’s share price was at $70, was he working harder than he is now when Intel’s stock is trading at $32? I don’t think so.

Even if he puts in 20-hour days for the next three months, will this budge Intel’s share price? Hardly. If all Intel’s workers begin to work round the clock, will it impact on the share price?

Not if the sector remains out of favour with investors and only if other computer company employees, (themselves holders of share options) act irrationally and do nothing to push up the share price of their companies.

If the average employee can’t move the share price by acting alone, then the shareholder is getting ripped off.

Only the most brilliant of chief executives can move the share price and even here the evidence in the face of the dotcom meltdown is scant.

When all shares are sky-rocketing due to a bull run, there appears to be a connection between the chief executive and the share price. When prices start falling, I’m not so sure.

Equally, where share options do change management behaviour, they may actually cause the executives in question to be more reckless with the firm’s capital and thus the shareholder’s capital.

When share prices fall, holders of options do not get penalised. Therefore options are all upside for managers and executives.

If they are lucky enough to be in place during a bull market, the salary is paid and their options go through the roof, subsidised by shareholders. When the markets turn down, shareholders get nothing back.

The recent implosion of technology, telecoms and dotcom shares suggests that share options do not create a plausible incentive structure. The financial model of 2000 — from hyping the company, to floating, taking over-optimistic shareholders’ money, expropriating as much as possible in options and hoping the stock rises — suggests corporate greed rather than corporate governance.

The verdict on excessive share options is still very much out. Does this form of compensation guarantee loyalty?

Only if nobody else is offering better deals. Can everyone offer better deals?

Yes, if the markets are rising. Do options drive a wedge between executives and employee? Clearly yes, as evidenced by the explosion in pay differentials.

Is it plausible to contend that share options enhance an individual company’s price performance? After last year’s meltdown, that contention — which is at the heart of share option logic — is hard to defend.

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