Commentary: Slimmer Rewards For A Job Poorly DoneJennifer Reingold
With the bull market forging ahead, investors may be blase about the costs of excessively generous stock-option compensation plans. Why quibble about a little dilution when prices are soaring? But regulators don't care about bull or bear markets. And fortunately for shareholders, the watchdogs are trying to ensure that options are used as rewards for good performance--not giveaways for execs that shareholders pay for.
The most important reforms involve repricing options. Some companies reissue options at a lower price when their share prices drop--a practice they say is necessary to hold on to key executives. Shareholder activists say repricing is unjustified because it essentially rewards executives for poor performance at a time when investors are suffering. The Financial Accounting Standards Board (FASB) has come up with a new interpretation of an existing rule that would force companies to account for repriced options as an expense. Today, the costs of options--including repricing--are not charged to earnings. The proposal would make repricing much costlier and, presumably, discourage the practice.
STIGMATIZED. Companies are taking the proposal, which will soon be circulated for comment, seriously. After the announced in early December that the proposal could affect repricings done after Dec. 15, companies responded with a rash of repricings in an attempt to beat the cut-off. Timothy J. Sparks, head of compensation and benefits at Wilson Sonsini Goodrich & Rosati, a Silicon Valley law firm, says he worked on some 100 repricings as Dec. 15 approached. "There was a pretty good crowd at the exit," he says. There also were plenty beforehand. E*Trade Group Inc. repriced its options in October at a split-adjusted $8.50. Since then, the stock has traded as high as 62 7/16.
Trade groups such as the Software & Information Industry Assn. oppose the 's plan, saying repricing is part of keeping critical employees. But opposition has been relatively muted, perhaps because repricing bears a stigma--it can let execs benefit unduly from a stock's fall. "It's like arguing about jail time for child molesters," says pay consultant Frederic W. Cook, who believes the proposal will pass easily. "Repricing is dead."
Repricing is also an issue at the Securities & Exchange Commission. In December, the agency told General DataComm Industries Inc. that it had to include a proposal by the State of Wisconsin Investment Board (SWIB) in its proxy statement banning repricing without prior shareholder approval. The proposal was slated for a Feb. 4 vote. "By holding the feet to the fire on shareholder approval, you're better off," says Patrick S. McGurn, corporate programs director at proxy advisor Institutional Shareholder Services. Currently, companies can reprice at will, but they must disclose it in the proxy. The sec's shift lets shareholders speak out before the repricing is done--a smart move.
But while and the sec attack option abuses, the New York Stock Exchange could be promoting them. The Big Board approved a rule last April that would make it easier for companies to issue new options without shareholder input. No vote is now needed if a company's option plans include 20% of eligible employees, at least 50% of whom aren't officers or directors.
The ruling brought an outcry from investors such as the SWIB and the Council of Institutional Investors, a group representing over 100 pension funds. Now, even a NYSE task force's proposed compromise on the matter has stalled. "We can't think of an issue that matters more," says Sarah A.B. Teslik, executive director at the Council. "If [we] were to go down in flames on anything, it would be this."
They're right. Option plans, if abused, can dilute shareholders' holdings and reward mediocre performance. As owners of companies, shareholders should have the right to vote on matters that may dilute their stakes. In a time of option mania, the and the sec are adding needed clarity, but the Big Board should go back to the drawing board.
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