The Next Options Scandal - How to pay executives under the table

Marc

Hunkered Down for the Duration with a Mask on...
Staff member
Admin
#1
From the Washington Post:
The Next Options Scandal - How to pay executives under the table

June 11, 2006

SINCE 1995 American business has performed far better than it did in previous decades and far better than rivals in all other rich economies. Productivity has boomed because executives have risked trying out new ways of doing business, even if those changes were wrenching and made executives unpopular in the short run. To motivate managers to take these risks, it makes sense to tie pay to performance; stockholders will benefit and, overall, most workers should also benefit, since strong corporate performance is a necessary condition for rising wages, even if not a sufficient one. This is why it can be wise to reward executives with stock options. But it's also why the abuse of options matters: Abuse discredits a financial tool that can boost the dynamism of the economy.

The latest abuse concerns the suspicious dates on which options are granted. At more than 30 companies, executives have received options on a day when their firm's share price was at a low; the subsequent rise in the price has made the options valuable. As the Wall Street Journal has reported, top executives at KLA-Tencor Corp., a maker of semiconductor equipment, were awarded options on two days in 2001. The first day marked the low point of the firm's share price in the first half of the year. The second day marked the low point in the second half.

The chances of this being a coincidence are around one in 20 million. It seems likely, therefore, that the options were gamed: Perhaps the issue date for the options was chosen retrospectively, so that the firm could look back on a six-month period and pick the most advantageous date from the point of view of the executives. If so, a mechanism that was supposed to reward performance was used instead to pay bosses irrespective of performance. The aim was to disguise the scale of executive pay and to make it look more merit-based than it was.

Executives and directors from at least 20 companies are under investigation for options timing by federal or state officials. But this scandal, coming on top of the long-running reluctance of firms to count options as a business expense, may broaden enough to raise questions about the use of executive options across corporate America. Executive compensation is inherently open to abuse: The directors who set bosses' pay are technically independent, but they often have joined the board at the invitation of the chief executive and, unless the firm is in crisis, have no strong incentives to hold down executive pay or be otherwise tough on senior managers. Introducing an opaque form of payment such as options into this setting increases the potential for abuse. If firms want to preserve options as a respectable form of compensation, they must bend over backward to show that they are using them responsibly.
 
Elsmar Forum Sponsor

Wes Bucey

Quite Involved in Discussions
#2
The problem with publicly held companies from time immemorial has been that powerful executives trump the interests of the shareholders by limiting the choices of "outside" directors to individuals who may be chosen
  • simply for the "marquee value" of the director's name
    or
  • because they are "go along to get along" cronies of the powerful executive.
Marquee value guys (like Kissinger and some Congressmen, sitting or recently "retired") extend themselves once or twice a year to making an "introduction phone call" to a potential new account (Dept. of Defense, etc.) and otherwise rarely put any effort into overseeing the business of the company.

The "go along" cronies are there to pick up the director fees and almost always vote with the administration desires.

Interlinked directorships were and continue to be a big factor in both US and European public companies where directors of company A select the CEO of that company to be a director on Company B. This has long been a factor in playing "freezeout" with newcomers to an industry where bankers who are directors of a company in that industry actively blackball loans to newcomers who would be competitors to the company where they are a director. Obviously, the quid pro quo is the company favored then does its main banking business with the director's bank to generate fees and even direct commissions for the director.

The opportunities for abuse abound:
  • favorable dating of options
  • golden parachute contracts
  • off-books dealing (Enron)
  • overpriced banking agreements
  • stock price manipulation
  • labyrinth "bribes" to officials at governments or companies who buy from Company A by funneling their bribes through options at company B or getting favorable rates on personal loans from Company A's bank.
Suffice to say, there is a lot of conversation between directors at a company which is not done in front of a stenographer acting as recording secretary.
 
R

roland_lu

#3
How are the odds computed?

The first day marked the low point of the firm's share price in the first half of the year. The second day marked the low point in the second half.

The chances of this being a coincidence are around one in 20 million.
While I see and agree with the conclusions, I do not understand the 1 in 20 millions chances, would anybody explain further? my guess was 1/120 trading day *1/120 trading days, round up to somewhere 1 in 15000, impossible to be a coincidence
 

Wes Bucey

Quite Involved in Discussions
#4
roland_lu said:
quote (The first day marked the low point of the firm's share price in the first half of the year. The second day marked the low point in the second half.

The chances of this being a coincidence are around one in 20 million.)

While I see and agree with the conclusions, I do not understand the 1 in 20 millions chances, would anybody explain further? my guess was 1/120 trading day *1/120 trading days, round up to somewhere 1 in 15000, impossible to be a coincidence
I'm certain the 20 million number was chosen for dramatic effect, but the odds are MUCH higher than what you suggest, since option dates are usually set to coincide with a company accounting period (month or quarter), not a "random" date. Alternately, the date may be set as of the date of employment for the individual or, rarely, to give a tax advantage to the recipient by setting it on the day before or after the last day of the recipient's tax year. Such protocols alone would increase the probability against hitting historic low by a factor which could bring the number up high enough to raise suspicion. When that happens for multiple individuals at multiple organizations, the odds of ALL setting their dates at the absolute lowest point is pretty fantastic, while the odds of the next guy getting such a deal is much lower than 20 million. (We may need someone like Professor Tim Folkerts to help us calculate true probabilities.)
 

Tim Folkerts

Super Moderator
#5
Wes Bucey said:
IWe may need someone like Professor Tim Folkerts to help us calculate true probabilities.
:lol:

Based simply on probabliity, I agree with roland_lu's assessment. 1/15,000 is a more reasonable estimate of the odds. You would need to have about 4500 choices for each option date to get a figure like 1/20,000,000. Perhaps they not only got the right dates, but the right hours for the low during each six month period. :D

As Wes B pointed out, though, granting stlock options would usually not be done simply at random. This factor, thought is very hard to quantify mathematically.


Tim F
 

Wes Bucey

Quite Involved in Discussions
#6
This so-called scandal could result in some serious repercussions for the publicly traded companies involved. As this follow-up story shows, big time investors (in this case, Calpers, California Public Employees' Retirement System) are flexing their muscles and could oust some directors AND executives from companies where they have big positions and these funds have the wherewithal to sustain lawsuits against various executives to reclaim ill-gotten option gains for the investors.

It is important to understand that a pension fund as big as Calpers can rally lots of other pension funds and mutual funds to march to its tune PLUS press and electronic media are eager to report anything Calpers offers. The combination of financial and public relations muscle can often work a lot faster to change conditions than the glacial pace of SEC and local attorneys general.
Job site Monster joins companies under options review
Monday June 12, 3:39 PM EDT
By Michele Gershberg

NEW YORK (Reuters) - Online job site Monster Worldwide Inc. (MNST) and four other companies on Monday disclosed investigations by U.S. authorities into executive stock options grants, widening a scandal that now involves some 40 companies.

The growing investigation into the suspicious timing of stock options in a possible effort to boost their value has also prompted CalPERS, the largest U.S. pension fund, to request explanations from 25 companies.

Monster said on Monday it had been subpoenaed by the U.S. Attorney for the Southern District of New York and pledged to cooperate fully with the inquiry.

Earlier Monday, the company said a committee of independent directors would analyze its options practices following a Wall Street Journal report that questioned whether grants were backdated or timed ahead of sharp rallies in its stock price.

Shares in Monster, the largest U.S. recruiting Web site, dropped as much as 9 percent, prompting some analysts to raise their view of company risks.

"While we continue to view near and long-term operating fundamentals favorably (for Monster), the overhang created by this investigation will likely keep a cap on shares," wrote Goldman Sachs analyst Peter Appert in a research note.

Appert downgraded the share to "in-line" from "outperform." Robert W. Baird & Co. also lowered its rating on the share to "neutral" from "outperform."

Microchip maker Broadcom Corp. (BRCM) and data center services company Equinix Inc. (EQIX) each said they had received informal requests for information from the U.S. Securities and Exchange Commission over their options grants.

Medical device maker Cyberonics Inc. (CYBX) said it had been contacted by the SEC, despite a company denial last week of possible improprieties raised by a securities analyst.

Applied Micro Circuits Corp. (AMCC) said it was also subject to an informal inquiry by the SEC, while Comverse Technology Inc. (CMVT) and its former subsidiary Ulticom Inc. (ULCM) delayed filing first-quarter results due to their ongoing investigations.

NEW SECTORS JOIN MOSTLY TECH-RELATED PROBES
Technology companies, which have relied heavily on options packages to boost executive and employee salaries, have been the most vulnerable to such probes to date.

Large companies from other sectors under internal or outside investigation include insurer UnitedHealth Group Inc. (UNH) and education provider Apollo Group Inc (APOL).

Federal prosecutors and securities regulators are weighing the type of legal action that could be taken over options packages that appear to have been dated retroactively to take advantage of a low share price or timed ahead of good news.

The probes have prompted share declines and in some cases, executive dismissals or shareholder lawsuits.

In a further sign of potential fallout, the California Public Employees' Retirement System (CalPERS), a pension fund with more than $200 billion in assets, said on Friday it had asked explanations from 25 companies identified in the media for questionable options practices.

"These allegations raise concerns about a lack of oversight by the Board of Directors, weak internal controls, weak internal and external audit practices, and poor accounting -- as well as the possibility of civil and criminal penalties against these companies," said Christianna Wood, CalPERS Senior Investment Officer for Global Equity, in a statement.

CalPERS sent letters asking companies already in the process of reviewing their options grants, such as Affiliated Computer Services (ACS) and Comverse, to disclose publicly their findings and any new policies they may set regarding option grant dates.

Monster shares dropped $3.09 to $38.91 after trading as low as $38.30 early in the session. Comverse slid more than 12 percent to $20.64 to a new year low, Equinix fell 5 percent to $53.44 and Cyberonics lost more than 3 percent to $21.91.

Bucking the trend, Applied Micro was nearly unchanged while Broadcom rose nearly 2 percent to $29.80.

©2005 Reuters Limited.
So . . . if you were on the Board of Directors of a publicly traded company today, do you think you would be revisiting the option deals granted to the company executives to see if they pass the "smell test?"

I fear some directors may have been dazzled by receiving simultaneous option deals themselves.

This is certainly a good example of the need for "risk analysis" of compensation deals for company executives and the directors.
 

Wes Bucey

Quite Involved in Discussions
#7
Tim Folkerts said:
:lol:

Based simply on probabliity, I agree with roland_lu's assessment. 1/15,000 is a more reasonable estimate of the odds. You would need to have about 4500 choices for each option date to get a figure like 1/20,000,000. Perhaps they not only got the right dates, but the right hours for the low during each six month period. :D

As Wes B pointed out, though, granting stlock options would usually not be done simply at random. This factor, thought is very hard to quantify mathematically.


Tim F
My first blush view is that ANY ONE single deal "might" have odds as low as 1/15000 to hit the lowest strike price. What are the odds of ALL 25 companies getting the lowest strike price (understanding each company has a different "best price" date?) What did they do different than companies which have not come under suspicion? Is it truly a mathematical coincidence or are there factors which raise the stink level?

If I were a forensic accountant looking at this deal, I'd want to know if there was a difference in dates between options granted this year versus those granted last year. Does the company have a pre-published formula for selecting the "as of" date? My guess is the deals did not pass the preliminary smell test and thus the attorney general wants to get FACTS to bolster his suspicion.

I know, I know, the odds of the next company getting the best price date would still be 1/15000 without taking the "protocols" in account. That was never the point of the "20 million" comment.
 
Thread starter Similar threads Forum Replies Date
W Next Calibration Due Date Calibration Frequency (Interval) 5
E Our company is planning to file MDD not MDR next month. Do we require to show chemical characterization report ? CE Marking (Conformité Européene) / CB Scheme 2
Y ASQ CQE and CSSGB; What next? Career and Occupation Discussions 1
M What to Expect from Next IEC 60601-1 and IEC 60601-1-2 Amendments? IEC 60601 - Medical Electrical Equipment Safety Standards Series 7
Sidney Vianna Interesting Discussion ISO 9001:2024 - What should be changed in the next Edition of ISO 9001? ISO 9000, ISO 9001, and ISO 9004 Quality Management Systems Standards 113
M Informational EU – Next Notified Body designated to the MDR 2017/475 is IMQ S.p.A from Italy Medical Device and FDA Regulations and Standards News 0
M Informational Next meeting of the Medical Device Coordination Group (MDR/IVDR) – 20 June 2019 Medical Device and FDA Regulations and Standards News 2
D Necessity of external watchdog next to internal watchdog ISO 14971 - Medical Device Risk Management 1
C Acquiring an IATF 16949 Certified Company - What happens at the next audit? IATF 16949 - Automotive Quality Systems Standard 4
K Everybody ready for round 2? Our next audit is in late January IATF 16949 - Automotive Quality Systems Standard 9
B Interview Presentation for Quality Engineer Role Next Week! Career and Occupation Discussions 21
B I have CSBB Cert - CQE vs. CMQ/OE next? Professional Certifications and Degrees 4
qualprod Risk closeout , mitigation was not effective, next? ISO 9000, ISO 9001, and ISO 9004 Quality Management Systems Standards 12
A Passed the AATT Exam - What come comes next? AS9100, IAQG, NADCAP and Aerospace related Standards and Requirements 2
F Supplier Audits - Creative ways to gain confidence in the next Supplier Training - Internal, External, Online and Distance Learning 6
Q Passed ASQ Certified Quality Process Analyst Exam! What next? Professional Certifications and Degrees 7
P Is the next revision of ISO 15378 following the High Level Structure? Other ISO and International Standards and European Regulations 5
I What are considered next generation ITSM tools? IT (Information Technology) Service Management 1
rob73 New MDD (European Medical Device Regulations) next steps - 2016 EU Medical Device Regulations 1
L Where next? Thinking outside the QMS box Career and Occupation Discussions 9
C Quality Assurance Manager ? Next Steps? Quality Manager and Management Related Issues 10
B Chi-square test - What do I do next? Statistical Analysis Tools, Techniques and SPC 2
S QSB+ revoked - Notify registrar, what's next? Customer and Company Specific Requirements 3
hogheavenfarm Suggestions for next Professional Certification Professional Certifications and Degrees 11
S What are the next steps after providing response to FDA 483 ? US Food and Drug Administration (FDA) 7
P Do CQE exam questions repeat in next exams? Professional Certifications and Degrees 1
B Anyone Attending OTC next week in Houston? (Offshore Technology Confernce) Oil and Gas Industry Standards and Regulations 0
T FDA Form 483 Warning Letter - What next? US Food and Drug Administration (FDA) 7
S Delegation of Response to Next Level ISO 9000, ISO 9001, and ISO 9004 Quality Management Systems Standards 2
K Building Heavy Pollution Factory next to Medical Device Factory (ISO 13485) ISO 13485:2016 - Medical Device Quality Management Systems 6
S Update from Australia and NZ regulatory bodies - ANZTPA in next 5 years Other Medical Device Regulations World-Wide 0
W ISO 9001 Certified - Active Six Sigma - What Next? Quality Manager and Management Related Issues 25
F Career Problem - Industrial design, QA, what next? Career and Occupation Discussions 5
Michael Malis FDA final version of Strategic Priorities for the next 5 years US Food and Drug Administration (FDA) 1
2 Next Version of ISO 27001 and Likely Areas with Changes? IEC 27001 - Information Security Management Systems (ISMS) 7
somashekar Supply Chain Oversight is the FDA's Next Area of Concern Other US Medical Device Regulations 0
F What's the next step after failing an AQL? Inspection, Prints (Drawings), Testing, Sampling and Related Topics 7
E What's next after all the certificates and awards? (e.g.: ISO 9001, ISO 1400, etc.) Occupational Health & Safety Management Standards 1
B The next (5th) revision of ISO 9001 - When available? ISO 9000, ISO 9001, and ISO 9004 Quality Management Systems Standards 6
K Procedures and Quality Manual written - Where next? ISO 9000, ISO 9001, and ISO 9004 Quality Management Systems Standards 14
L Calibration - Buying New Tools - How do you determine the next calibration date? General Measurement Device and Calibration Topics 12
xcanals_tecno-med.es MDD 93/42 as amended by dir 2007/47 in force next week (21 mars) EU Medical Device Regulations 2
N What sampling plan should I use for the next lot. Inspection, Prints (Drawings), Testing, Sampling and Related Topics 2
O Need to Create Macros so that it can copy data to the next row.... Excel .xls Spreadsheet Templates and Tools 5
C What is the next ISO 9001? 9001:2009 or 9001:2014 or? ISO 9000, ISO 9001, and ISO 9004 Quality Management Systems Standards 1
P PMA called for a class III-510(k)..what next? US Food and Drug Administration (FDA) 4
T What is the status of the next version of ISO 14001? ISO 14001:2015 Specific Discussions 72
K Status of ISO 17025 (Next Revision, Which Committee does it?) ISO 17025 related Discussions 2
Wes Bucey If you get laid off this Friday, what's next? Career and Occupation Discussions 12
L SC in a circle next to feature box - Is this "Statistical Control" Inspection, Prints (Drawings), Testing, Sampling and Related Topics 17

Similar threads

Top Bottom