Monday, February 26, 2007

Another Look at "Lucky" Options Grants

Photobucket - Video and Image Hosting In an earlier post (here), The D & O Diary commented on the research published by Lucian Bebchuk of Harvard Law School and two colleagues, in which they examined over 19,000 options grant awards between 1996 and 2005, finding a disproportionately higher number of grants on the date during the month with the lowest share price. In an article in the March/April 2007 issue of Harvard Magazine entitled “’Insider Luck’: How Stock-Option Grants Were Gamed – And What to Do About It” (here), Bebchuk elaborates and comments upon his research.

A portion of the magazine article summarizes Bebchuk's previously released study, in which the researchers found that 12% of all CEO options grants were “lucky grants,” defined as grants awarded on days on which the stock price was at its monthly low. (The research findings are summarized in my prior post, linked above.) The magazine article adds the further research finding that “opportunistic timing has not been limited to executive’ grants; rather it has been present to a significant degree in outside directors’ grants as well.” The research showed that about 9% of the grants to outside directors were “’lucky’ events taking place on dates with stock prices at monthly lows.” Bebchuk reports that the opportunistic timing was spread over about 460 companies, and that “in companies in which opportunistic timing of options awards took place, luck tended to lift the boats of both executives and outside directors.”

Bebchuk emphasizes that the research showed that “most companies have not engaged in such timing in awarding options,” but that certain factors were associated with a higher likelihood of lucky grants. The option grants were more likely to be “lucky” when the potential payoffs were relatively high, and opportunistic timing was “correlated with increased influence of the CEO on the company’s internal pay-setting and decision-making process.”

Bebchuk goes on to note that the “fact that many outside directors were themselves recipients of lucky grants reinforces the view that opportunistic stock-options awards were produced by governance failures, not business decisions made rationally and in good faith to serve shareholder interests.” Bebchuk concludes by commenting that “even though significant backdating may belong to the past, its underlying causes are problems with which the corporate governance system must continue to wrestle.”

Bebchuk’s research and commentary are interesting. But I have begun to be a little suspicious of research studies showing that backdating took place at a very large number of companies, far greater than the number that have announced backdating problems so far. We are now nearly a year beyond the first wave of media attention surrounding the backdating issue. How many more companies can there be out there yet to divulge options grant manipulations? If Bebchuk’s numeric research conclusions are not ultimately borne out, are his other conclusions and comments adequately supported? To be sure, there may yet be many companies about to reveal options timing problems, and Bebchuk’s research could be validated by forthcoming disclosure events. At this point, I have become a little skeptical that there are as many companies yet to reveal options timing problems as Bebchuk’s research would suggest.

Losing AIM?: In prior posts (most recently here), I have suggested that global financial markets are evolving, and that factors that may have made London’s Alternative Investment Market (AIM) more attractive than U.S securities markets in the last few years may be changing on their own. A February 22, 2007 article in the U.K.-based LegalWeek.com entitled “Losing AIM – Three Years of Market Boom Has Come to an End” (here) confirms that "the twin shadows of market indigestion and long-simmering concerns regarding the quality of companies floating has finally called a halt to the AIM express.”

The article notes that the recent headlines regarding Torex Retail (see my prior post, here) “have taken their toll, though regulatory concerns have been brewing for months.” Although the article optimistic about the prospects for renewed future prosperity on the AIM, it does acknowledge that right now, the market is going through a “necessary correction.” As one commentator quoted in the article says, “we are paying the price for the number of deals done in 2005 for companies of questionable quality.”

Contrary to the arguments of would-be reformers, the AIM experience is not bearing out the need for U.S securities markets to loosen their regulatory standards in order to compete in the global marketplace. To the contrary, the AIM experience increasingly is substantiating the need for markets to maintain their regulatory discipline in order to preserve investor confidence. Moreover, it appears that some of the differences in the global financial marketplace that have been driving competition in recent years are turning out to be transient, and are evolving. As The D & O Diary has frequently noted (most recently here), we should be very cautious about relying on transient phenomena as a basis for compromising the U.S. securities markets’ regulatory integrity.

Hat tip to Werner Kranenburg of the With Vigor and Zeal blog for the link to the LegalWeek.com article.

Practice, Practice, Practice? How you really get to Carnegie Hall -- refer here.

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