Warren Buffett's Opposition to Stock Options and Alternative Approaches

Buffett's Reasons for Opposing Stock Options as Executive Compensation

Warren Buffett has repeatedly expressed opposition to using stock options as executive compensation in his shareholder letters, primarily for the following reasons:

• Options Are Not Real Costs: Options are often viewed as "free" incentive tools but actually dilute shareholder equity. When executives receive options, they profit handsomely if the stock price rises but bear no losses if it falls. This asymmetric risk structure may encourage executives to pursue short-term speculation rather than long-term value creation.

• Susceptibility to Manipulation: Options incentivize executives to artificially inflate stock prices through accounting maneuvers, mergers and acquisitions, or share buybacks to profit from exercising options. This may harm the company’s long-term health and contradict value investing principles.

• Misalignment with Shareholder Interests: Options allow executives to act like "lottery ticket holders," enjoying upside gains without bearing downside risks. This fails to genuinely align executive interests with shareholders. Buffett considers this a "pseudo-incentive," as executives may prioritize personal wealth over the company’s intrinsic value.

Buffett’s Proposed Alternatives

Buffett advocates for using restricted stock or requiring executives to purchase company shares with their own funds as compensation forms. Specifically:

• Executives may receive performance-based bonuses to acquire company shares, which could be subject to holding-period restrictions (e.g., non-transferable for several years).
• Alternatively, grant restricted stock directly but require executives to hold it for a specified period to ensure long-term commitment.

Advantages of the Alternatives

Compared to stock options, Buffett’s alternatives offer the following advantages:

• Better Alignment of Interests: Executives must invest their own capital to acquire company shares, becoming genuine shareholders who share both upside gains and downside risks. This encourages a focus on long-term value growth rather than short-term stock fluctuations.

• Reduced Manipulation: Since shares must be purchased and held, executives are incentivized to make decisions favoring sustainable corporate development, avoiding speculative tactics to boost stock prices.

• Greater Fairness and Transparency: This approach treats compensation as a real cost, making it easier for shareholders to understand and evaluate. It avoids the accounting ambiguities of options while aligning with the core principle of value investing—emphasizing intrinsic value over market speculation.

• Enhanced Executive Accountability: With "skin in the game" like ordinary shareholders, executives develop a stronger sense of ownership, improving corporate governance. Buffett’s similar approach at Berkshire Hathaway demonstrates its effectiveness.