China’s Execs Sweating Over Stock Options

After nine years and billions of yuan in cash-ins, China is again reviewing stock options for state-owned company chiefs.

"Every day, I felt like I was sitting on a bomb just waiting to explode," said a former senior executive at one of China's major oil companies, CNOOC (NYSE: CEO, HKSE: 00883).

This executive with a ticking time bomb under his leather chair was referring to his own indecision over exercising stock option rights he earned before leaving CNOOC.

Such anxiety is common in China's executive suites. And now government regulators, who have been honing stock option incentive rules since 1999, are moving to tighten the reward programs that allowed many company chiefs to pocket huge sums � despite an initial premise that options were merely "nominal" rewards.

Stock options are mainly offered to managers and highly skilled professionals in China. They are supposed to link salaries to a company's long-term interests by allowing holders buy a certain amount of company stock at a pre-set price, with a view to profiting from rising stock values.

One executive treasure chest is stashed at China Mobile (HKSE: 00941, NYSE: CHL). The company saw its stock price soar as high as HK＄ 158 per share last October 29, sending the market value for its stock options skyrocketing to HK＄ 174 million.

Across the country, several individual executives can boast option book values that exceed 100 million yuan. But option-holding executives at Chinese, overseas-listed companies still speak about the issue privately; it's taboo in public. Why the whispers? Because the windfall potential has escalated in step with rising stock prices for overseas listed SOEs.

In years past, stock options were considered nominal incentives because, in the eyes of many, all senior executives at SOEs were picked and appointed by the Communist Party under the assumption their stock options would never be fully exercised.

Today the idea of nominal stock options is dead. Among overseas listed SOEs, barriers to exercising stock options have been overcome, and some senior executives have received substantial rewards.

China Mobile � the world's largest mobile phone services provider by customer base � is among them. The company launched a stock option incentives program in 1997, before the government officially started regulating stock options. The first recipients were the company chairman and senior executives. Later, the program was extended to branch executives.

Wang Jianyu, president of China Mobile, told Caijing his company's options program was not a product of imagination but shaped with "a substantial, realistic touch." China Mobile's practice proved that stock options are "extremely beneficial" as incentives for employees, he said.

In particular, they've been good for management types. So far, 354 million China Mobile stock options have been exercised, earning the holders a combined HK＄ 11.1 billion. Meanwhile, the telecom giant still has about 500 million stock options waiting to be exercised that could earn HK＄ 65 billion, based on a share price of HK＄ 130.

Other SOEs have tried to follow China Mobile's lead, and some are currently in the process of crafting options programs. Yet experiences vary from one company to the next. Moreover, some programs have stumbled.

"These stock options are all fake," an executive at PetroChina told Caijing. "Besides the stock option contract, we sign another contract which commits (executives) to 'not exercise these rights with liberty.'"

Checkered History

SOEs generally adopted stock option programs after the government released a 1999 policy statement for SOE reform and development. The policy said SOEs should link management income with business performance. A few enterprises were selected for an annual salary pilot project that included stock option rights. Options and other means of distributing compensation can be explored and advanced with experience."

Liu Ming of Hay Group Consultancy, which designed stock option programs for several big-name SOEs, remembers that many early plans were based on the government policy document.

Nevertheless, between 2000 and '04, regulatory officials focused more attention on option program details. In 2000, for example, a new law said high-skilled specialists who made contributions to companies could be rewarded with stock options or discounted stock.

A new wrinkle emerged when SOEs started trading stock on overseas markets. One source said that, in 2001, several SOEs that listed overseas got Ministry of Finance permission to exercise stock option rights. Among these, telecommunication operators were in the forefront because they were considered more closely linked to the marketplace.

At the time, the Chinese concept did not sell well on overseas markets. Overseas investors in companies such as China Mobile and PetroChina were concerned about whether stock option incentives could be effectively executed.

"Many investors viewed this (incentive program) as an important benchmark as to whether SOE leaders could be responsible for their enterprises," said one senior executive at China Investment Corp., the investment bank that helped PetroChina list on the Hong Kong exchange.

And low compensation figures gave overseas investors the jitters. As recently as seven years ago, SOEs were hesitant to reveal their executive salaries. Yang Xianzu, chairman of China Unicom (HKSE: 00762, NYSE: CHU), stated in 2000 � when the company kicked off its IPO campaign � that the monthly salary for one of the company's senior executive was less than 10,000 yuan.

Nevertheless, those who exercised their stock options made considerable amounts of money. And that led to more rule-making.

A new, trial policy that put constraints on incentives took effect in March 2006. It said stock options should not exceed 10 percent of a company's capital base. The policy, called Measurement for State-owned Overseas Listed Companies, was released by the State-owned Assets Supervision and Administration Commission (SASAC), the investor representative for all state-owned enterprises outside the finance sector.
The policy also set a two-year wait for exercising stock options, and said the options should be rewarded every two years. Recipients had to be senior executives or highly-skilled professionals, the policy said, and earnings from expected stock options should be capped at no more than 40 percent of an annual salary.

Facing this new circumstance, many top executives decided against exercising their option rights. Nor did they explicitly state that they would give up their rights. These included PetroChina former chairman Ma Fucai, Sinopec ex-chairman Li Yizhong, the former chairman of CNOOC Wei Liucheng, and Bank of China-Hong Kong former chairman Liu Mingkang.

Yet, implementing this policy proved challenging. Nearly a year after it took effect, SASAC announced that "some overseas listed companies have not gotten their stock option programs approved by the authority. Some programs did not follow the law because stock options were rewarded too frequently, lock-up periods before exercising options were too short, and stock options were excessively given out. Also, some performance evaluations were poorly structured or non-existent."
But a source admitted that the law never ruled out rights to exercise stock options. "If managers want to exercise these rights, they should do it quietly, or they should be sure that their staff will not file grievances," the source said.

SASAC took another step in October 2007 with an announcement regarding "rigorously regulating overseas listed SOEs that provide stock option incentives."

Meanwhile, the Ministry of Finance, which oversees state-owned financial institutions, began to strengthen implementation of stock options among Hong Kong-listed financial SOEs.

The ministry also ordered suspensions of stock option programs at China Life Insurance (HKSE: 02628), People's Insurance Company of China PICC (HKSE: 02328), and the Bank of Communications (HKSE: 03328). Plans for programs at the country's three, largest commercial banks � Bank of China (HKSE: 03988), ICBC (HKSE: 01398) and Chinese Construction Bank (HKSE: 00939) � are still under regulatory review.

Meanwhile, the finance ministry has been working on a new policy to regulate state-owned financial institutions for shareholding related incentives. A ministry source said no shareholding incentives would be reviewed until after the next policy is released.

Quality managers deserve stock option incentives, but only if the reward system harmonizes with corporate governance.

When state-owned enterprises (SOEs) started incorporating and going public several years ago, some adopted stock option incentive plans. More recently, SOEs have faced decisions about exercising these rights. The fact that options may create remarkable wealth stirred public debates. Stock option rights incentives are in line with China’s market reform and represent an important breakthrough in reform for modern enterprises.

At the same time, stock option incentives at SOEs are market newcomers and highly policy-oriented. More changes are in store, reflecting accumulated experience, in the areas of corporate governance, the policy environment and the marketplace.The theory behind the release of Decisions on SOE Reform and Development by the 15th Central Committee of the Communist Party in 1999 solved the problem of shareholding for staff and management, and laid a good foundation for stock option incentives.Stock options are a good incentive for Chinese managers during the current economic transformation. High quality managers are scarce. We do not have the conditions for hiring talent on par with international standards. Several prerequisites are needed. First, we need good corporate governance with investors as the incentive subject and management as the incentive object. Second, we need a solid and market-oriented talent selection platform. Third, a rather mature capital market should be put in place so that stock prices can honestly reflect the basic conditions at each company.Our current personnel system for senior management is a two-way system that includes primary “internal” administrative appointments coexisting with secondary “external” market selections. As a person is appointed senior manager inside the system, he or she is promised a long-term career including bonuses and promotions, provided there are no major mistakes on the job. Internal promotions have wider connotations, meaning that not only job-related promotions are expected but also that they may include corresponding appointments to administrative positions within the government. In contrast, managers on the external market selection track are weighed according to the market benchmark.The SOE management debate for exercising stock options reflects two considerations. First, for administratively appointed managers, a stock option is an extra motivation on top of internal system incentives. Second, stock prices for some SOEs that dominate certain sectors do not necessarily reflect the performance and contributions of management. The core controversy is that administrative appointments do not match market-driven incentives.

However, stock option incentives at SOEs must help improve and reform corporate governance as well as monopolized industries, which are core reasons for SOE reform. Rather than twisting stock option rights to adjust to the traditional personnel system and monopolized sectors, it is better to advance our personnel system, improve corporate governance and reform monopolies.

So, at the end of the day, what is the solution? For those widely criticized cases, what can be studied is whether their corporate governance and monopoly levels are applicable to the marketplace. Also, further down the road we should decide whether all shareholders should get the final say in issuing stock option incentives.Policy Timeline for SOE Stock Option Incentives1999 – The 15th Central Committee of the Communist Party released Decisions on SOE Reform and Development, which stated that SOEs should “link management income with business performance. A few enterprises were selected for an annual salary pilot project that included stock option rights.

Options and other means of distributing compensation can be explored and advanced with experience.”

August 1999 – The Ministry of Science announced that IT enterprises can award the management based on increased value of net assets.

September 2000 – The Ministry of Finance chose IT enterprises at the Zhong Guan Village, a technology area of Beijing, for pilot projects in shareholding and share options.

June 2001 – The China Securities Regulatory Commission (CSRC) announced, according to the Ministry of Finance, official acknowledgement and support for bonus awards at listed companies. Also, the authority stated that related accounting should be regulated.

November 2002 – A report by the 16th National People’s Congress said “principle contributions that participate in the distribution of compensation should consider production elements such as labor, capital, technology and management. (We) should improve the compensation system so that wealth distribution based on labor coexists with other means of wealth distribution.”

April 2003 – The Ministry of Finance said that “before relevant regulations advance, management buyouts of listed and non-listed companies should be suspended for the time being.”December 31,

2005 – CSRC released on a trial basis the policy document Measurement for Stock Options Rights in Listed Companies.

March 2006 – The Remuneration Bureau at the State-owned Assets Supervision and Administration Commission (SASAC) released on a trail basis the policy Measurement for State-owned Overseas Listed Companies.

May 2008 -- CSRC released Memorandum for Stock Options Incentives.