Share Options and Perverse Incentives (Nokia and Elop)

Outrage about the amount Stephen Elop is getting (Euros 18.8m) for selling the mobile phone part of Nokia to Microsoft extends from the Finnish Prime Minister to the editor of the Financial Times. It is not helped by the fact that Mr Elop left Microsoft to join Nokia as CEO, and is now returning to them. Mr Elop did not manage to really revive the mobile side of Nokia while he was there, although some might say he established a base for the future, and it was a pretty dire situation when he joined in 2010.

What are the facts of the matter? Most of the above compensation arises from share options that are “crystalised” because of the change of control. It is very normal to have a change of control clause in share option agreements and there is a very good reason for such a clause. If for example, you worked for a public company, but it was taken over by a private company, then your options would potentially have no value because there would be no market for the shares you have options over.  That would also generally apply if you are taken over by a public company where typically the company shares of the takeover target are delisted. So if share options are a substantial part of your potential overall compensation, no executive would sign a share option agreement without such a clause in it.

The main reason why Mr Elop is “earning” such a large figure is apparently because he was granted large numbers of options at a low price, and the share price of Nokia shares has gone up by two-thirds since the deal was announced.

One has to question whether such arrangements provide perverse incentives though. Obviously it made more financial sense for Mr Elop personally to close this deal with Microsoft rather than wait for a recovery of the company.

This is not a new problem. It arose, for example, at BAE Systems when the merger with EADS was being proposed. The CEO, Ian King, was reported at the time to likely obtain £18m from the crystalising of share options if the deal went through. You can see why he might have been keen on it, when others thought it was a pretty daft idea that would never get approval by shareholders.

Now share option agreements usually have performance clauses, and of course time duration clauses (not all options vest immediately). But these clauses can be wiped out by the “change of control clause”, so performance does not have to be achieved, and in no period of time. The problem therefore is not the principle of cystalisation, but the details of the contract. In addition, some share option contracts are simply too generous.

As it was, the board of Nokia agreed Mr Elop’s contract so they need to pay up. But at least they have persuaded Microsoft to pay 70% of the award.

Roger Lawson

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