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.
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.
