How to Think Like Benjamin Graham and Invest Like Warren Buffett

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about 5% of annual earnings among S&P 500 companies and in
some cases amounting to half of reported earnings, including at Ya-
hoo!, Polaroid, and Palm.^9 In less dramatic but still striking exam-
ples, if stoc koptions were recorded as a cost, the 1999 earnings of
some major companies would be slashed: Cisco, 24%; Microsoft,
12%; IBM, 8%; and Oracle, 16%.^10
These cost effects extend for many years, depending on the life
of the options. At many companies, options have a life of five years.
Increasingly, companies extend their lives to as long as 10 and 15
years.

Accountability

Legal rules are ill equipped to police executive compensation. The
general stance of U.S. courts is to evaluate compensation issues, if
at all, under a waste standard. This standard rarely upsets corporate
decisions. Waste requires pretty much the irrational trashing of cor-
porate assets in ways akin to dumping truckloads of cash into the
Hudson River. In the case of executive compensation, U.S. courts
are quite deferential to management indeed.
As for securities disclosure laws, the SEC requires substantial
and focused disclosure of top executive compensation in compara-
tive performance charts. Nevertheless, corporations continue to
structure executive compensation packages so that they don’t show
up in the bottom-line numbers. For example, after accounting stan-
dard setters ruled that a reduction in the exercise price of a previ-
ously issued option had to be recorded as an expense on the income
statement, many companies chose instead to extend the life of the
option.
Without effective legal or accounting regulations, the chief job
of policing executive compensation lies with the corporate board.
Board members must insist that executive compensation peg indi-
vidual contributions to corporate performance. Measuring executive
performance by business profitability is the most definitive yardstick
with regard to shareholder as well as labor interests. When measur-
ing performance, companies should reduce earnings by the capital
employed in the relevant business or by the earnings the firm retains.

Caveat

While Warren Buffett tends to share these criticisms of stoc koption
compensation packages, he is careful to record the following caveat: