Despite the long-running bull market, some shareholders’ smiles fade when the topic of stock options arises. Organizations that benefit from stock-based compensation plans can prevent shareholders’ mood from souring by strengthening the link between stock options and shareholder value creation, and by effectively communicating this connection to investors.

In this era of strong corporate earnings, shareholders are a pretty happy bunch. But one cloud looms on the horizon of shareholder relations — the continuing proliferation of stock options and other stock-based compensation plans. Most shareholders recognize that stock-based incentives have increased the value of their holdings, and many credit the proliferation of stock options with driving the tremendous stock market gains in recent years. However, some institutional shareholder groups, concerned about overhang (the sum of previously granted options and options available for future grants, as a percentage of total shares outstanding) and the dilution of share value that results from excessive overhang, are increasingly voting down plans that come before them for approval.

The amount of compensation offered through stock options has risen dramatically over the past few years, and concerns have grown with it. "Ten years ago a large, mature company would award one-half of one percent or one percent of its total stock in stock options," said Richard Semler, principal, world practice leader, management effectiveness and rewards, with compensation consultancy Sibson & Co. in Los Angeles. Now those levels are extending well into the double digits in some companies, as stock option grants get larger and reach deeper into the organization.

As a result, more shareholders than ever are willing to vote "no" on the stock-based compensation plans that come before them, according to Semler. "It used to be unusual to see a vote with less than 80 percent of shareholders approving stock-based plans," he said. "Now, it is not unheard of to see 55 percent approval rates. A lot of companies are struggling with these issues." Despite this erosion in support, stock-based compensation plans are rejected only extremely rarely. Of course, no one is tracking "the plans that were never brought to vote because there was no support," noted Matt Ward, senior consultant, chairman and CEO of compensation consultancy WestWard Pay Strategies in San Francisco.

Senior management shoulders much of the blame for this state of affairs. "Companies assume that shareholders understand the benefits of these programs," but that is not always the case, said Patrick S. McGurn, director of corporate programs for Institutional Shareholder Services (ISS), a proxy advisory and research firm in Rockville, Md. "A growing number of companies now see a 30 to 40 percent opposition rate, which is setting the stage for a problem. Companies have to get a strong message out to shareholders and communicate the value of these programs."

So far, shareholder resistance has not reached the boiling point, thanks largely to a long run of impressive stock market performance, but it continues to simmer below the surface. Therefore, companies must deal with this issue proactively. They need to examine the effects of their stock-based compensation plans on share value. Businesses which find that their plans are not benefiting shareholders should take steps to strengthen the link between executive compensation and shareholder value creation. Then companies must communicate to shareholders precisely how and why the incentives increase share value.