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December 19, 2004

Another Thing I Should Read More Often

Dean Baker's Economic Reporting Review.

"In the Timing of Option, Many, Um, Coincidences" Gretchen Morgenson: New York Times, December 5, 2004, Section 3, Page 1: This article reports on a new study showing that the issuing of stock options to top executives seems to precede the announcement of good news for corporate earnings. This indicates that companies are effectively giving unrecognized compensation by allowing top executives to buy stock (through purchasing options) in advance of market rises.

Posted by DeLong at December 19, 2004 07:17 AM

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Tracked on December 19, 2004 01:31 PM


But, business is good and all CEOs are upstanding citizens who would never bend or break the rules to enrich themselves.

If they did, the free market would punish them. The free market solves all. The free market is good. The free market would never stand for this... Now as penance for your doubts, say three Hail Markets and three our Our Free Markets.

Posted by: section321 at December 19, 2004 10:09 AM

I am shocked ... *shocked* ... at such practices.

You can bet that board members who approve such option grants also tend to get stocking stuffers at the same time.

Posted by: Observer at December 19, 2004 10:26 AM

How long could this work? It seems to me the people in the know - investment bankers and the like - would start paying attention to when their clients issued stock options and buy at the same time; then people would start paying attention to them etc. etc. etc. Pretty soon the whole market is buying when options are issued - end of advantage.

Posted by: flory at December 19, 2004 10:36 AM

Reporting good news after giving options makes sense as a cover - the management is saying "Look, we've done well so we desrve the reward". The executives cannot sell stock right after getting options - there are vesting periods and other restrictions.

Posted by: a at December 19, 2004 11:01 AM


Are Options Seducing Directors, Too?

TRYING to extricate company directors from their chief executives' pockets has been at the heart of many changes in corporate governance during these dizzying scandal years. Indeed, the most commonly cited cure-all for what ails corporate America is director independence.

But all the independent directors in the world cannot seem to fix perhaps the biggest problem facing shareholders: egregiously high and ever-rising executive pay. Even though members of companies' compensation committees now must be independent, executive pay just keeps on rocketing.

A new study by academics at Baruch College, part of the City University of New York, offers a possible explanation of why this may be. You may not be shocked to learn that - once again - it's about money.

Donal Byard and Ying Li, both assistant professors of accountancy at Baruch, analyzed stock option grants given to chief executives at United States companies from 1992 to 2002. The sample was large - almost 18,000 grants - and the study confirmed other academic research showing that options are very often granted to executives just before good news about the company is disclosed or directly after bad news. No companies were identified in the study.

The study also found that the practice of bestowing well-timed option grants - which the professors called "timing opportunism" - has become more prevalent in recent years. Puzzled by this, the professors said they decided to dig further. So they looked at how directors were paid and found that timing opportunism was more pronounced when directors on the compensation committee received a larger proportion of stock options in their pay package.

As a result, the professors said, a heavier reliance on stock options in the pay of independent directors more effectively aligns their interests not with the shareholders to whom they have a duty, but with top management.

"Since outside directors frequently receive options at the same time as C.E.O.s," the study noted, "these directors also benefit from any timing opportunism. We argue that when outside directors receive a lower proportion of their compensation from stock options, they are more likely to limit C.E.O.s' timing opportunism."

The trouble, at least from a shareholder's perspective, is that stock options are growing as a percentage of the compensation that outside directors receive for serving on a board. During the first half of the study's 10 years, for example, the professors found that option grants averaged 16 percent of directors' pay. During the second half of the period, option grants averaged 46 percent of the pay to directors. In the technology sector, the percentages can be far higher. In some cases, stock options make up 100 percent of directors' pay.

For example, the most recent proxy filing from Siebel Systems, a company that makes software for managing customer relationships and for other purposes, noted that none of its outside directors received cash for their services beyond reimbursement for expenses they incur. Instead, they get options. New directors at Siebel, for example, receive options on 80,000 shares; each year thereafter they get 20,000 options for their board service.

"We believe that these option grant guidelines will motivate and reward our nonemployee directors for their service in a manner that is consistent with good corporate practice and the independence requirements of the Nasdaq National Market applicable to members of boards of directors and compensation committees," the filing said.

Options are also big at eBay, the online auction company. Outside directors receive options on 15,000 shares at each annual meeting; new directors who are not employees of eBay also receive $150,000 worth of what the company calls deferred stock units. One-quarter of these units vest on the first anniversary of the grant, while the rest vest monthly. Outside directors at eBay also receive $50,000 in cash plus $2,000 in fees for each meeting attended.

EBay's proxy filing from last June also noted that in 1998, before it became a public company, it had granted an option to a director to buy 1.8 million shares of its stock at an exercise price of $0.78 each. The company's shares closed Friday at $114.41.

To be sure, no one is saying that executives at Siebel or eBay are timing their option grants.

Posted by: anne at December 19, 2004 11:25 AM

flory wrote, "Pretty soon the whole market is buying when options are issued - end of advantage."

But you're making assumptions about the speed with which the issuing of options must be reported.

Posted by: liberal at December 20, 2004 06:47 AM

And as I figure it, if I were issued an option on a stock, and the market then figures that the stock in question is bound to increase in value, and so buys at an increasing price, then I'm in better shape. I have a higher probability of the option being worth exercising.

Posted by: Barry at December 20, 2004 12:14 PM