Commentary: How To Reward Failure: Reprice Stock Options

How do you make outright greed palatable to disgruntled shareholders? Henry R. Silverman, chief executive of troubled Cendant Corp., seems to think that he and his board have found a way. Between April and late September, Cendant shares were ravaged, dropping from 41 3/8 to under 12, by revelations of massive accounting fraud. The drop made most of Silverman's stock options look pretty unattractive. So, rather than take the hit, the board simply agreed to reprice over 17 million of them, cutting some strike prices in half.

Option repricing is hardly new, and with stock prices tumbling, many companies are tempted to lower the strike prices on executive option plans to current market levels. This is not going down well with some institutional investors, such as the State of Wisconsin Investment Board, which has lobbied nearly two dozen companies to put proposals to reprice up for a shareholder vote.

"SERIAL REPRICERS." Despite this opposition, repricing has picked up steam. In fact, executive pay consultant Graef S. Crystal dubs some companies "serial repricers." Apple Computer Inc. has the dubious distinction of topping this list, having reset option prices nine times in its brief life. Advanced Micro Devices Inc. has repriced a half-dozen times; Cypress Semiconductor has done it five times, including twice in one week back in the late '80s. Admittedly, high-tech companies, which use options to lure talent, need to keep options attractive. More recently, though, companies like retailer Winn-Dixie are getting into the game.

To disarm the most vocal critics, CendaNt added a new wrinkle. First, the company pulled a Washington trick: It floated a trial balloon to see how shareholders would react. Without major opposition surfacing immediately, it went forward with a novel game plan: Rather than reprice Silverman's 25.8 million options that were "underwater," the board canceled one-third, repriced one-third at current prices, and repriced the final third at a 50% premium. Even Crystal, a vociferous critic of repricings and excessive executive pay, has been mollified. "Other companies will look to Cendant as an example of how to do [option repricings] the right way," he says.

For the sake of shareholders everywhere, let's hope they don't. The accounting debacle at Cendant, in which some former execs have been accused of fraudulently inflating income by $500 million over three years, has cost Cendant shareholders nearly $26 billion. Although Silverman doesn't appear to be directly responsible for the accounting games, he acquired the company and management now being blamed for the disaster. "It was the lack of due diligence that caused the stock to crash," insists Charles M. Elson, a professor at Florida's Stetson University College ofLaw. "Repricing his options is effectively rewarding him for failure. The shareholders don't have that option for their investment. Why should he?"

It's a good question. Silverman, who didn't own a single share of Cendant outright, didn't suffer any real loss. He already had absurdly outsize stock-options grants on 46.3 million shares, which once gave him a theoretical net worth nearing $835 million. His "paper" losses of some $600 million are just that. "You'd like to see Silverman share some of the downside risks that shareholders have already been asked to bear," says Patrick McGurn, vice-president of Institutional Shareholder Services Inc.

So where to draw the line? At the very least, every proposal to reprice existing options should be put to a shareholder vote. No less important, repricings for top execs make no sense under any conditions. Stock options are long-term incentives that should not be used to reward a management that fails to produce results.

If anything, Cendant's repricing confirms the need for new accounting treatment for stock options. The Financial Accounting Standards Board is proposing that all repriced options be charged to earnings. The hit would be so considerable at some companies that it would widely discourage repricings. That's a good idea. And Cendant can be the FASB's exhibit A.

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