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The AAO Weblog covers accounting issues and current events as they relate the practice of investment analysis. All posts prior to September, 2007 are in the public domain, but after September 4, only subscribers to The Analyst's Accounting Observer will see all posts going forward. Only selected, occasional posts will be released to the public domain from September 4 forward.
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| Options By-product: "Special Committees"
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Location: Blogs AAO Weblog (Public) |
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| Posted by: Jack Ciesielski |
5/9/2006 7:14 AM |
One supposed rationale for the issuance of options was the way that they'd fund new jobs: if a firm didn't have enough cash to actually pay someone what they were worth, why, they could make up the difference with stock options. That would also increase their incentive to produce results - and the economy would benefit from incremental jobs that got created that would otherwise be snuffed if employers had to pay people with something as passe as cash.
Lately, as the SEC's investigation of options backdating continues to spread, there have been other jobs created by the issuance of stock options: the rise of the "special committee" of a firm's board charged with investigation of improper handling of options grants.
Just this morning, a couple more special committees were announced, another example of options creating wealth - for lawyers and teams of forensic accountants. This time, the wealth is being created by Altera Corporation as reported by Reuters. If Altera sounds familiar to you in connection with options, that's because it's the firm that excoriated an analyst from Wells Fargo for having the nerve to criticize the firm's share buyback practices, designed to offset the firm's option issuances.
Altera joins a lengthening list of companies either considering their practices on their own or being investigated by the SEC: Comverse Technologies, UnitedHealthcare, Analog Devices, Vitesse Semiconductor, Power Integrations, Brooks Automation, and the granddaddy of them all, Mercury Interactive.
You could write them all off as harmless non-cash transactions, and maybe try "buying on the dips." After all, if there's any restatement involved, it's only about past history, right? (Whether or not there will be restatements required is not something very "projectable" from the investor's seat. From the outside, investors can't tell if options have been backdated or not; they won't know what dates should have been used, or what strike prices were proper; they won't be able to tell if backdating was proper under the companies' plans and if the issue is really a disclosure problem; and they won't be able to figure out if any amount of compensation that should have been recognized is material enough to trigger a restatement. Advice: let the special committees do the heavy lifting. If you even come close to guessing the actual outcome, it would be more luck than skill.
If investors think that this these investigations represent a buying opportunity, they should think again. The instances where real wrongdoing is uncovered, once they're completely rooted out into the harsh sunlight of the day, should illustrate clearly how corrosively options comp can affect management judgment. Would you really want those kinds of managers to be acting on your behalf?
Yes, Virginia, they're derivative instruments. When we worry about derivatives we usually concern ourselves with something like the credit derivatives market and the possible systemic market effect of a failed counterparty. Employee stock options are derivative instruments in every sense of the term, and while they don't pack the same systemic fright wallop as a self-immolating California county, the degree to which they can persuade managements to do something in their own interests ahead of shareholders is shocking enough. Maybe it's because some of the evidence of what they've been doing with stock options has always been cloaked in secrecy: no recognition of stock compensation in the financials, offsetting dilution by using shareholder cash to buy back shares, and now the developing "shooting fish in a barrel" scandal.
Options, in and of themselves, aren't bad things. Neither are derivatives. For that matter, neither are steroids. What they all have in common is that they promise outsized returns for minimum investment. And that can have negative consequences on the judgment of people who aren't emotionally or mentally equipped to handle them. At least with options, some of the accountability is improving. |
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