The public outrage against chief executives and their option-bloated pay is strong. The disgust is heard from investor comments on Sound Money. The ill temper over CEOs walking away with extraordinary wealth while shareholders suffer billions of dollars in losses goes all the way up the investor spectrum to capitalist icon Warren Buffett.

Investors are right to be angry. CEOs have become all too adept at reaping gains from gargantuan stock option packages no matter how their company performs. Here’s one example drawn from a long list: Over the three-year period 1999 through 2001, shareholders in high-tech behemoth Cisco Systems watched their returns fall by 22 percent while CEO John Chambers collected some $279 million. Little wonder the backlash against options is gaining momentum on Wall Street and in Congress.

Still, despite the abuses, options are a valuable tool for rewarding managers and workers. Let’s take a step back in economic history. It’s worth recalling that U.S. companies stumbled terribly in the 1970s. Industrial America lost market share and profits to Japanese, German, and other overseas rivals. Management adopted a risk-averse mentality (no innovative ideas, please), loaded up on executive perks (get it while you can), and isolated themselves from shareholders (the CEO as emperor). This executive mindset was an economic catastrophe.

In the '80s, T. Boone Pickens, Michael Milken, Henry Kravis, and other financial gunslingers shook up America’s defeatist establishment. But too many of their targeted companies foundered on the leverage these financiers favored. Instead, stock options in the '90s proved to be a much better financial instrument for aligning management and shareholder interests, as well as a way of encouraging an entrepreneurial mindset among executives. Options played a role in the longest expansion in U.S. history.

But the turn of the century has exposed some basic flaws in the current generation of option packages. For one thing, corporate boards are far too generous in granting stock options. There’s no excuse for that level of fiscal irresponsibility, and it should stop immediately. For another, many CEOs are earning a windfall for doing nothing more than riding a rising stock market. Corporate boards should “index” executive options to a benchmark such as the S&P 500. Managers would only profit from their options to the extent that their initiatives beat any market-wide stock movements.

By indexing options, the grants would reward the extraordinary entrepreneur and not the ordinary caretaker.