Tying CEO pay to stock is a blunt instrument

— -- Stock options have long been used to compensate CEOs so they get fat checks only when their shareholders profit.

But many are starting to rethink the effectiveness of options, because in up stock markets, every CEO is paid like a genius. In down markets, CEOs good and bad are rewarded like dunces. Some companies did better than others last year, but many stock options are still under water — meaning they're worthless.

Critics say options encourage overly risky behavior by top management. Claudia Allen, head of Neal Gerber & Eisenberg's corporate governance practice group, says there is nothing inherently wrong with CEOs getting incentives to produce long-term value for stockholders. However, large option grants, may cause executives to take excessive risks.

That belief is increasingly supported by academic research. One study called "Swinging for the Fences," published in 2007 in the Academy of Management Journal, concluded that big option packages may cause more harm than good.

CEOs who have been loaded with options can get extremely rich when the stock goes up, but there is a floor on the downside, because worthless options, while a lost opportunity, don't make them lose any money.

That equation compels them to take inordinate risk — known as "swinging for the fence" — and they strike out more often than they hit home runs, say study authors Gerard Sanders of Rice University and Donald Hambrick of Penn State University.

They found that when stock-option grants constituted half or more of the CEO's pay, 10% of stocks suffered big shareholder losses, while only 6.8% enjoyed big gains, a significant difference, they say. Where stock options constituted less than 20% of CEO pay, 4.7% enjoyed big shareholder gains, and 2.2% sustained big losses.

University of Texas at Dallas finance professor David Mauer concluded in a separate study that options encourage risk. "These findings may help put the nail in the coffin of executive stock options," he says.