A gorgeous woman slinks up to a CEO at a party and through moist lips purrs, "I'll do anything - anything - you want. Just tell me what you would like." With no hesitation, he replies, "Backdate my options."
So goes a new rendition of the jocular tale that Warren Buffet used in his annual letter to Berkshire Hathaway Investors a few years ago. In a fit of blatant pandering, boards have acted foolishly to give top management an unearned perk.
More than 100 companies are under government investigation for charges related to backdating executive stock options. Executive departures related to backdating already have taken place at Apple Computer Inc., software firm Comverse Technology, computer-security firm McAfee, CNet Networks, and the UnitedHealth Group. Who will be next?
The most recent dramatic development is the case of Dr. William W. McGuire, a medical entrepreneur who built the UnitedHealth Group into a colossus in its field. He was forced to resign from the company early this week and forfeit a portion of the $1.1 billion in stock he holds.
Stock options give executives, or other workers, the benefit of buying stocks at the price it was sold one time the exercise price and then selling for a presumably higher price later on, based on the companies successes where the workers and executives presumably contributed to make them higher.
Companies that backdate their options select a date for the option that is often earlier than when the grant is made. This allows them to choose a date when the value of the option is more favorable to the employee receiving it, which inflates executive payouts when the options are exercised.
I realize their temptation. I am on the board of a public company (TWL Knowledge Group) that offers stock options to board members and executives. Just last month I received some stock options and the transaction was appropriately filed with the SEC. The value of the options was determined by the stock price on the day of its granting. By sheer bad luck, the stock price went down on the day of the granting. A week earlier and my options would have had more value. So what do you do? You just shake your head, and do your best to lift the performance of the company. Cheating is not an option.
The option backdating story broke several months ago when the Wall Street Journal looked at companies' grant dates for executives and found that at several companies, option grants usually occurred on days when the stock price was much lower than normal, and in some cases, grants occurred on the day with the lowest stock price of the whole fiscal year. The Journal calculated that the probability that these grant dates were continuously selected by chance was extremely low, in some cases odds of 1 in 6 billion.
At UnitedHealth, there was strong evidence that options were backdated for employees between 1994 and 2002. The most substantial were those awarded to Dr. McGuire, the company's long-time chairman and chief executive. Of the 12 options grants issued to Dr. McGuire, three just happened to be priced at the stock's lowest price that year
Maybe it's not surprise that Silicon Valley is ground zero for the stock options fiasco. It developed an entrepreneurial culture that held up stock options as the best way to get rich quick. John Coffee, director of the Center on Corporate Governance at Columbia Law School, calculates that approximately 29% of all companies between 1996 and 2005 manipulated or backdated their stock options in at least one or more cases.
The practice of secretly backdating options hurts us all - it cheats all investors and undermines the public confidence in the capital markets. The irregularities are far-reaching. They may force the companies to erase reported earning, which will turn years of profit into an illusion.'
Perhaps most important of all, backdating options sends out the wrong message to every employee in a company. Stock options were meant as rewards for actual performance. It is hard to hold non-executive employees to standards of excellence when their leaders are patted on the back for mediocrity.
Do you think executives should be fired if it is shown that they have backdated their options? Share your opinion:
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