Enabling all this is the SEC, the U.S. government agency that is supposed to regulate the stock market to prevent manipulation of stock prices. In fact, since 1982, under Rule 10b-18, the SEC has not only enabled but even promoted stock-price manipulation. That’s in addition to sanctioning a mismeasurement of executive compensation that obscures the ways in which senior executives benefit personally from the manipulative boosting of their companies’ stock prices.
Given that the SEC requires companies to report their executives’ ARG, how did it come to be that EFV became the go-to metric for corporate leaders’ pay? Ironically, the SEC’s mismeasure of executive pay evolved largely as the result of the agency’s attempts, starting in the early 1990s, to make companies’ reporting of executive compensation more rigorous. In response to growing concerns about soaring executive pay in the late 1980s and early ‘90s, the SEC in 1994 replaced the proxy statement’s Cash Compensation Table, in which the only data reported for the company’s highest-paid executives were salary and bonus compensation, with the Summary Compensation Table, which contained data on many additional components of pay. That year, the SEC also had companies report ARG from the exercise of stock options (but not the vesting of stock awards) for the executives named on proxy statements, but that information wasn’t required to be in the new table. At this point, EFV played no role in the filings.
During the 1990s, it was the business-run Financial Accounting Standards Board (FASB) that was interested in EFV because of the rise of stock options as a means of compensating a broad base of professional, technical, and administrative personnel, especially at technology companies such as Intel, Microsoft, and Cisco. The asset managers of pension funds and mutual funds were concerned that as thousands or even tens of thousands of a company’s employees exercised their options, the dilution of the company’s shareholdings would have a negative impact on the market prices of stocks in the funds’ portfolios. To help guide their decisions concerning the buying, holding, and selling of shares, the asset managers asked the FASB to come up with an up-front estimate of the cost of all these broad-based stock options. In calculating these estimates, the FASB favored Black-Scholes-Merton option-pricing models, which were devised by economists as part of the movement to create financial derivatives.
Then, with the bursting of the stock-market bubble in 2001 and the bankruptcy at the end of that year of Enron, transparency in corporate accounting and reporting took on a new urgency, leading Congress to pass the Sarbanes-Oxley Act of 2002. As part of this effort, the SEC, relying on the FASB’s accounting standards, beginning in the 2006 fiscal year required companies to use EFV for the stock-based compensation of all their employees, to be recorded in their income statements contained in an annual filing to the SEC known as a 10-K.