Comments on: Lucky CEOs and Directors: How Serious is the problem? http://blogs.law.harvard.edu/corpgov/2006/12/22/lucky-ceos-and-directors-how-serious-is-the-problem/ Sponsored by the HLS Corporate Governance Program Mon, 07 Jul 2008 02:05:38 +0000 http://wordpress.org/?v=wordpress-mu-1.2.1 By: Andrew Clearfield http://blogs.law.harvard.edu/corpgov/2006/12/22/lucky-ceos-and-directors-how-serious-is-the-problem/#comment-22 Andrew Clearfield Mon, 22 Jan 2007 00:50:11 +0000 http://blogs.law.harvard.edu/corpgov/2006/12/22/lucky-ceos-and-directors-how-serious-is-the-problem/#comment-22 The real problem with backdated options--as we are now discovering thanks to the revelation that many directors were also rewarded with them--is not that there is a pervasive culture of illegality among American senior managers, but that there is widespread willingness to ameliorate or dispense entirely with performance hurdles in order to guarantee that executives (and directors) receive good bonuses no matter what. This makes a mockery of assurances to shareholders that strong performance is a necessary precondition for receipt of large bonuses and grants. It also demoralizes staff and lower levels of management, because their bonus awards are very strictly preconditioned upon meeting performance targets. The resulting message is that senior managers live by a different set of rules, and that there is a positive incentive for cheating, or at least gaming the system. This is corrosive on many levels, and promotes irresponsibility throughout the economy, not least among institutional investment managers. The real problem with backdated options–as we are now discovering thanks to the revelation that many directors were also rewarded with them–is not that there is a pervasive culture of illegality among American senior managers, but that there is widespread willingness to ameliorate or dispense entirely with performance hurdles in order to guarantee that executives (and directors) receive good bonuses no matter what. This makes a mockery of assurances to shareholders that strong performance is a necessary precondition for receipt of large bonuses and grants. It also demoralizes staff and lower levels of management, because their bonus awards are very strictly preconditioned upon meeting performance targets. The resulting message is that senior managers live by a different set of rules, and that there is a positive incentive for cheating, or at least gaming the system. This is corrosive on many levels, and promotes irresponsibility throughout the economy, not least among institutional investment managers.

]]> By: John Olagues http://blogs.law.harvard.edu/corpgov/2006/12/22/lucky-ceos-and-directors-how-serious-is-the-problem/#comment-12 John Olagues Sat, 23 Dec 2006 18:38:42 +0000 http://blogs.law.harvard.edu/corpgov/2006/12/22/lucky-ceos-and-directors-how-serious-is-the-problem/#comment-12 Will Rogers once was asked what was the best way to make money in the stock market. He replied that "Its simple, you buy and when they go up you sell, and as far as the ones that don't go up you don't buy those." Of course few people know whether they will go up when you buy. But executives know for sure when they will go up because they seem to have permission to buy after they have gone up at prices of the stock before they have gone up. They also certainly have inside information that allows thwm to be granted options prior to good news and dodge the bad news. And when trading with the company as in the case of options grants approved by complicit Compensation Committees, the size of the trade is unlimited with no fading by the seller as would be the case if they were buying listed calls from traders. Its true that a listed call with a strike price of 20 to buy shares at 25 may be worth just 2 dollars more than a call to buy the stock at 25 when its trading at 25. But a call to buy the stock at 20 when it is trading at 25 is worth 3 3/4 more than a call exercisable at 20 when it is trading at 20. For earnings purposes, the expense of the above back dated grant is almost 45% less than it should have been. The same analysis applies to spring loaded options grants. But the real options abuses are not back dating or spring loading. The real abuse takes place when the executives and the compensation committee get together and quitely transact a large batch of options grants to re-load a large batch of options just exercised and the stock sold. Further more, the SEC facilitated these practices by promulgating rules in 1996 that vitiated Section 16 b of the Securities and Exchange Act of 1934, and now the chickens have come home to roost. Stock options used properly is a fine tool for companies. Unless there are agressive prosecutions of civil and criminal practices by the government and restrictive rules put in place, you can kiss options good bye. John Olagues Will Rogers once was asked what was the best way to make money in the stock market. He replied that “Its simple, you buy and when they go up you sell, and as far as the ones that don’t go up you don’t buy those.”

Of course few people know whether they will go up when you buy.

But executives know for sure when they will go up because they seem to have permission to buy after they have gone up at prices of the stock before they have gone up.

They also certainly have inside information that allows thwm to be granted options prior to good news and dodge the bad news. And when trading with the company as in the case of options grants approved by complicit Compensation Committees, the size of the trade is unlimited with no fading by the seller as would be the case if they were buying listed calls from traders.

Its true that a listed call with a strike price of 20 to buy shares at 25 may be worth just 2 dollars more than a call to buy the stock at 25 when its trading at 25. But a call to buy the stock at 20 when it is trading at 25 is worth 3 3/4 more than a call exercisable at 20 when it is trading at 20.

For earnings purposes, the expense of the above back dated grant is almost 45% less than it should have been.

The same analysis applies to spring loaded options grants.

But the real options abuses are not back dating or spring loading. The real abuse takes place when the executives and the compensation committee get together and quitely transact a large batch of options grants to re-load a large batch of options just exercised and the stock sold.

Further more, the SEC facilitated these practices by promulgating rules in 1996 that vitiated Section 16 b of the Securities and Exchange Act of 1934, and now the chickens have come home to roost.

Stock options used properly is a fine tool for companies. Unless there are agressive prosecutions of civil and criminal practices by the government and restrictive rules put in place, you can kiss options good bye.

John Olagues

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