Tuesday, September 26, 2006

"Dating Games"

M. P. Narayanan, Cindy A. Schipani, and H. Nejat Seyhun, a trio of professors at the Stephen M. Ross School of Business at the University of Michigan, have authored an interesting article on the "true" costs to shareholders of the burgeoning options backdating scandal.

The article, The Economic Impact of Backdating of Executive Stock Options:
provides an estimate of the value loss incurred by shareholders of firms implicated in backdating and compares it to the potential gain that executives might have obtained through backdating.
The study found that:
revelation of backdating results in an average loss to shareholders of about 8%.
For firms ensnared in the options-backdating scandal that amounts to an average loss of market capitalization of half a billion dollars.

The average potential upside for the executives at the firms involved in options-backdating - less than $600,000 per company per year.

The disproportionality of those figures led the authors to draw a comparison to Martha Stewart's conviction for obstruction of justice. Her alleged gain (really an avoided loss) was less than $50,000 but resulted in a market capitalization drop of approximately 40% for shareholders of Martha Stewart Living Omnimedia (NYSE: MSO) in 2002 when news surfaced of Martha's sale of ImClone Systems (NASDAQ: IMCL) stock.

The authors go on to suggest a number of remedies for both backdating and other options-related malfeasance, such as springloading.

Among the possible solutions:
  • Require companies to report both the date the board or compensation committee finalized the option award details, and the actual grant date.
  • Remove the short-swing profits exemption (Section 16(b) of the Securities and Exchange Act of 1934) for shares obtained from option exercises.
  • Prohibit annual option awards from being effective on a single date, and instead divide the grants into twelve equal installments awarded on a monthly basis, at the same time executives receive their basic pay.
  • Explicitly include the granting of compensation options (and the acquisition of shares through exercises of those options) as falling within the general insider trading provisions of Section 10(b) of the Securities and Exchange Act of 1934.
The article will be published in the June, 2007 issue of the Michigan Law Review.

Two of the authors have an entire site devoted to their stock options dating research - Dating Games: Backdating & Forward-dating of executive stock options. Of particular interest on the site - a timeline tracing the early history of the option backdating scandal.

Daily Trivia: Michigan's business school is named for Stephen M. Ross, the founder, chairman and chief executive officer of The Related Companies, L.P. Related is the developer of the $1.7 billion Time Warner Center on Columbus Circle in New York City. Ross is also the nephew of the late industrialist and philanthropist Max M. Fisher. In recognition of Fisher's gift to The Ohio State University, the business school was renamed the Fisher College of Business.

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