Now that the U.S. Senate Finance Committee has returned from its summer holiday, members have put the recent spate of backdating stock options at the top of the agenda. Several professors from the business school at Washington University in St. Louis are ready to discuss the implications backdating has on corporations and shareholders.
It is believed that dozens, if not hundreds, of companies across the country may have improperly manipulated the dates of stock options grants to coincide with low points in the value of their companies’ shares. Among the many firms that have been implicated in options backdating are Apple Computer Inc., Comverse Technology, Brocade Communications Systems, Inc., Affiliated Computer Systems and Monster Worldwide Inc.
The reason that companies grant options is entirely logical, said Richard Frankel, associate professor of accounting. It’s a way to get managers on the same page with the shareholders.
“Managers don’t intrinsically have the same interest in growing the company as shareholders do; they tend to be more conservative,” Frankel said. “It’s especially costly for them if they make a decision that hurts the company, so they tend to be rather risk-averse.
“Options are intended to do two things: increase the correlation between a manager’s payout and the share price, and encourage managers to take risks,” Frankel said.
Options backdating just the latest abuse of a reward-system
Lubomir Litov, assistant professor of finance at the Olin School of Business said the prevalence of backdating stock options doesn’t surprise him. For one thing, executives have been shown to time options even before the backdating came to light. A study conducted by a New York University professor found that executives would time the granting of their options before good news was expected to come to light. Backdating options seems to be just another way for managers to compensate themselves, Litov said.
“Today academics and regulators alike are starting to view options – once properly thought of as a theoretically optimal way to align managers with shareholders – as another way to skim off the top from the company cash flow,” Litov said. “You see options used to take huge amounts of cash out of the company in a legal way. The problem is not as much in the nature of options as financial instruments, but more in their abuse, especially if accounting rule loopholes permit it and the audit committee willingly rubberstamps the CEOs decisions. Is this misuse endemic? I doubt it. A fairly large number of executives have been awarded options and added substantial value to their companies’ shareholders. So, where do we draw the line?”
All in all, Litov said, backdating of options comes in the context of known alternative ways to time executive compensation in a way that executives could maximize their own pay.
Editor’s note: Prof. Litov and Prof. Frankel are available for interviews. Television and radio can conduct live or pre-recorded interviews. Washington University has a broadcast-quality ISDN line and VYVX fiber-option video delivery in its on-campus studio.