As
if the behaviour by executives at Enron, WorldCom, HIH and One.Tel wasn’t bad
enough, the mainstream business press has latched on to another example of
shareholders being fleeced by greedy executives. In recent months, The Wall Street
Journal
has been reporting on a study conducted by a little-known
US-academic, Erik Lie, regarding backdating of executive options. Lie conducted
an exhaustive study on the timing of executive option grants and raised the
possibility that executives were backdating option grants so as to maximise
their own wealth, at the expense of shareholders.

The
issue was picked up by The Smageyesterday,
with US
reporter Mark Coultan noting that after analysing almost 6,000 option grants,
Lie found that:

[I]n the
month before options were granted, the share price dropped 3%, with most
of the drop occurring in the last ten days. After the options were granted, the
shares rose an average of 2% in the next ten
days, and almost another 2% in the next 20
days.

The
University of Iowa-based academic concluded that:

Unless
executives possess an extraordinary ability to forecast the future market-wide
movements that drive these predicted returns, the results suggest that at least
some of the awards are timed retroactively.

If Lie’s
findings are correct (and we will know more soon as the SEC is currently
investigating a number of companies who allegedly backdated options), the line
between CEO and common thief has just became a little more blurred. Backdating
options is tantamount to a CEO opening the till and pocketing as many $100
dollar notes as can fit in his Zegna suit. Consider this,
a CEO is granted 100,000 options on 1 July when the share price of his company
is $2.00. The share price then slips down to $1.00 on 1 September, only to
recover to $2.00 by 1 December. If the CEO backdated the option grant to 1
September (when the share price was at its lowest) he would have effectively
pocketed $100,000 a few months later at the expense of shareholders, for doing
absolutely nothing.

If Lie’s
claims are proven, the allegations would show yet again why
the grant of share options, while a noble concept if correctly utilised, is too
easily manipulated by rotten executives. This much was expressed by Warren Buffett way
back in his 1998, in his letter to shareholders, where he stated:

[T]hough
options, if properly structured, can be an appropriate, and even
ideal, way to compensate and motivate top managers, they
are more often wildly capricious in their distribution of rewards, inefficient
as motivators, and inordinately expensive for
shareholders.

While
senior Fortune writer Geoffrey Colvin has pointed out that the backdating of
options largely
ceased
after Sarbanes-Oxley came into force in 2002 (requiring companies to
report options grants within two days), this latest scandal goes to show that if
CEOs have the choice between themselves and their employer, too often it is the
shareholders who lose out.

Peter Fray

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