Quick Survey on Stock Plan Education
The NASPP and Fidelity Stock Plan Services are pleased to announce a joint survey on stock plan education programs. Take this quick survey today to find out how your education program compares to your peers’. The survey includes fewer than 25 questions; you can complete it in less than ten minutes—do it today, before you forget. The deadline to complete the survey is Friday, December 11.
New Studies
We’ve posted the following new studies to the NASPP website:
Risky Behavior and Stock Options The study, which is summarized in the article “The Making of a Daredevil CEO: Why Stock Options Lead to More Risk Taking,” published by Knowledge@Wharton, looked at companies that had recently experienced an increased risk and evaluated which companies took steps to mitigate that risk based on the percentage of their managers’ compensation that is in stock options and the in-the-moneyness of the options.
The researchers found that firms where managers held more stock options took fewer mitigating actions. They felt that this is because once stock options are underwater, the value of the options can’t get any lower. When you think about it, with full value awards, there’s always upside potential but there’s also always downside potential–until the company is just about out of business, the value of the stock can always drop further. But once an option is underwater, it doesn’t matter how low the stock price drops, the option can’t be worth any less. As a result, managers in the study that held more options were less incented to take actions to keep the stock price steady.
Risk and In-the-Moneyness
Interestingly, and in line with this theory, the study also found that when managers’ had in-the-money options they took more mitigating action than when their options were underwater. If there was some spread in the options, the managers were motivated to preserve that spread and thus took action to keep the stock price from dropping. But where there was no spread, the managers were more incented to take risks (presumably in the hopes that the risks would pay off and the stock price would increase).
This is all very interesting; I’ve often wondered (probably here in this blog even) why the media and investors have a bias for full value awards over stock options–I think this is the first plausible explanation I’ve heard for that bias. But here in the NASPP Blog, we view studies like this with a healthy level of skepticism–it’s odd but I’ve never seen a study that didn’t prove the researchers’ initial hypothesis–so I wouldn’t scrap your option plan in favor of full value awards just yet (if you haven’t already done so).
A Nail in the Coffin for Premium-Price Options
I’ve never been a fan of premium-priced options because the reduction in expense is less than the premium, which, to my mind, makes them an inefficient form of compensation. I prefer discounted options, which provide a benefit that exceeds the additional expense to the company.
If this study can be believed, premium options would also discourage executives from taking steps to mitigate risk (whereas discounted options would presumably have the opposite impact). Maybe regulators and investors need to reconsider their bias against discounted options (although, in the case of the IRS, this bias may have less to do with concerns about risk taking and more to do with tax revenue–see my March 16, 2010 blog, “Discounted Stock Options: Inherently Evil or Smart Strategy“).
NASPP “To Do” List We have so much going on here at the NASPP that it can be hard to keep track of it all, so I keep an ongoing “to do” list for you here in my blog.
A new study reporting that some CEOs make more than their companies pay in taxes has been making a splash in the media lately. Today I offer some comments on the study.
Executive Excess 2011: The Massive CEO Rewards for Tax Dodging The study looked at the 100 highest paid CEOs in the US and found that 25 of them earned more than their companies paid in taxes. The study also found that the average pay of the 25 CEOs exceeded the average pay of CEOs at all Fortune 500 companies, but, as one criticism of the study points out: “any subset of the 100 highest-paid CEOs in the country is going to have higher average pay than S&P 500 CEOs in general,” so this isn’t exactly groundbreaking.
The study also emphasizes that most of the 25 companies received tax refunds. Maybe I’m missing something here, but I thought getting a tax refund means you paid too much in tax, the IRS earned interest on your money all year, and then gave your excess payment back without interest at the end of the year. The companies that didn’t get a tax refund were the clever ones because they earned interest on their money all year, rather than the IRS–they aren’t necessarily paying their CEOs any less.
Compensation Apples to Tax Oranges
One problem I have with this study is that CEO pay isn’t directly related to the company’s tax bill. The two amounts really have nothing to do with each other. In fact, amounts paid to the CEO are an expense to the company; expenses reduce the company’s profitability which in turn reduces the amount the company pays in taxes.
Companies that aren’t profitable don’t pay any taxes. If CEO pay shouldn’t exceed the company’s tax bill, does this mean that CEOs at companies that aren’t realizing a profit shouldn’t be paid anything? That’s really going to put a damper on the start-up market.
Don’t get me wrong, I agree with the principle that many CEOs of public companies are paid excessively–I’m just not sure that the company’s tax bill is the appropriate yardstick by which we should determine what is excessive.
Is Senator Levin Behind This?
The study includes a special side bar (on pg 7) that explains how stock options contribute to this problem by producing a tax deduction for the corporation that differs from the expense recognized for the option–something Senator Carl Levin has been trying to change for years (see my August 9 blog, “Senator Levin, Still Trying“).
The study says that “The amount of compensation the executive receives on the exercise date is often substantially more than the book expense of the options…” I take issue with this statement. I’ve never seen any data to back it up, I don’t see any data backing it up in this study, and I know that many options end up underwater or result in a spread at exercise that is less than the grant date fair value. In fact, I’d love to see an analysis comparing grant date fair value to spread at exercise for a wide range of stock options at a wide range of companies, if anyone out there wants to take the project on.
CEOs Pay Taxes Too
One reason why compensation results in a tax deduction for the company is that the individual receiving the compensation pays taxes on it. So, while the company might be getting a tax break, the CEOs are still paying tax, probably a lot of tax.
NQSO exercises are certainly subject to tax. The US corporate tax rate for large public companies is around 34% to 35% (at least according to Wikipedia–I know nothing about corporate tax rates). The highest federal marginal income tax rate in the US is 35% and I have to believe that the CEOs in the study are paying tax at this rate (plus they are paying FICA taxes and the company is paying matching FICA taxes on the income). So whether the company pays tax on the income or the CEO does, it seems like the tax revenue is about the same (maybe slightly higher when the CEO is paying the tax because of FICA).
For example, let’s say that a company earns a profit $100 million and the CEO of the company holds an NQSO with a spread of $1 million. If the CEO doesn’t exercise the option, the company pays tax on $1 billion. If the CEO does exercise the option, the company pays tax on $99 million, but the CEO pays tax on the $1 million spread–at possibly a slightly higher rate than company would have paid. Tax revenue for the US federal government is about the same either way.
NASPP “To Do” List We have so much going on here at the NASPP that it can be hard to keep track of it all, so I keep an ongoing “to do” list for you here in my blog.
Now that the scandal, media frenzy, investigations (internal and external), prosecutions, and shareholder litigation seems to be winding down, a recently published academic study suggests that backdated options may not have done much harm to shareholders after all.
The real cost of stock options to shareholders is dilution, which is disclosed via diluted EPS. This calculation takes into account the strike price of the option, whether backdated or not, therefore, shareholders were aware of the potential dilution caused by backdating.
The reduced exercise price is more valuable to employees than the company’s cost for the discount. Thus, companies that granted backdated options may have been able to grant smaller options that were less dilutive than the options they would have granted if the options had been at-the-money at grant.
A Case for Discounted Stock Options
I was excited to see the paper, not because I think backdating is okay, but because I am a fan of discounted options. Under ASC 718, discounting an option doesn’t necessarily result in a dollar-for-dollar increase in the fair value of the grant. This makes discounted options a bargain from a compensation standpoint: the expense for the discount is less than the value delivered to employees (for this same reason, I’m not a fan of premium-priced options). The paper does conclude that there are situations where discounted stock options can be beneficial to both the company and employees.
Unfortunately, the very real obstacle of Section 409A still stands in the way of actually granting discounted options and, from a tax-revenue perspective, there are some valid reasons to discourage discounting (see my blog entry “Discounted Stock Options: Inherently Evil or Smart Strategy?,” March 16, 2010), so I don’t see this changing any time soon, study or not.
Flaws in the Study
There are also a number of flaws in the study. First, the study assumes that the company never realizes a tax deduction for ISOs and that ISOs have to be subject to vesting requirements–any Level I CEP candidate knows that both of these premises are false. In addition, the study assumes that stock options never qualify as performance-based compensation under Section 162(m). The authors in general seem to be very confused as to the operation of this area of the tax code.
Word of the Day
I did learn a new word when reading this study: “Pareto-improving,” which refers to something which harms no one and benefits at least one person. The authors conclude that, at least in some situations, backdated options can be Pareto-improving. I still haven’t figured out what sunspot equilibria are, though.
Only a Few Days Left for NASPP Conference Early-Bird Rate The 19th Annual NASPP Conference early-bird rate expires this Friday, June 24. This deadline will not be extended–register for the Conference today, so you don’t miss out.
NASPP “To Do” List We have so much going on here at the NASPP that it can be hard to keep track of it all, so I keep an ongoing “to do” list for you here in my blog.
Register for 19th Annual NASPP Conference (November 1-4 in San Francisco). Don’t wait; the new early-bird rate is only available until this Friday, June 24.
Attend the Silicon Valley NASPP Chapter All-Day Conference this Thursday, June 23. As I blogged about last week, I’ll be presenting on one of my favorite topics: Pumping Up Purchase Plans: Re-Thinking the ESPP. I hope to see you there!
Today’s blog looks at a couple of random topics that showed up in my recent Google alerts: 1) options backdating and lawsuits against auditors and 2) yet another study on stock options and employee performance.
Are Your Auditors Going to Get Fussier? Option backdating stories are few and far between these days, but a new development showed up in my Google alert this week. A federal appeals court has ruled that investors can move forward with a lawsuit against Ernst & Young over Broadcom’s option backdating scheme. The ruling reverses a lower court decision dismissing the case.
The lawsuit alleges that Ernst & Young should have investigated deficient and missing documentation relating to Broadcom’s option grants. At this point, the lawsuit has a long way to go–the ruling just allows the suit to proceed, there has been no finding or judgment against E&Y and perhaps there won’t ever be. Nevertheless, I think it’s intriguing that the lawsuits over option backdating have now extended to auditors. I’ve talked to many a stock plan administrator who has felt a bit put upon with respect to the documentation requested by their auditors, and that was before the options backdating scandal. I imagine the documentation requests have already gotten more onerous and, if this lawsuit goes much further, I can only anticipate that auditors will tighten up the documentation requirements even further.
Stock Options=Lottery Tickets=Grateful, Hardworking Employees The debate over whether stock options incent employee performance slogs on. The latest rebuttal is the paper, “Stock Option Exercise and Gift Exchange Relationships: Evidence for a Large US Company” by management professor Peter Cappelli and Martin J. Conyon, senior fellow at Wharton’s Center for Human Resources.
The study posits that stock options motivate employees to work harder, but not in the way employers most likely hope. Instead of working harder to increase the stock price before they exercise, employees view options more like lottery tickets. But, if they get “lucky” and are able to exercise for a profit, employees will work harder in the period following their exercise–often for over a year–in gratitude to the company for the payout they received.
The study examined exercise patterns and job performance of 4,500 managers at a large U.S. public company (unnamed). While the sample size of employees certainly seems large enough, the results would be more interesting to me if the study had looked at more than one company. The authors don’t seem to acknowledge the differences that education (both in terms of the stock plan and company financials) and corporate culture might have on how employees view their stock options and how that influences their performance. It would also be interesting to know if the results translate to restricted stock or RSUs, which guarantee a payout to employees.
It’s Not Too Late for the Online Fundamentals The NASPP’s acclaimed online program, “Stock Plan Fundamentals,” began last Thursday, April 14, but it’s not too late to participate. All course webcasts have been recorded and archived for you to listen to at your convenience. This is a great program for anyone new to the industry or anyone preparing for the CEP exam. Register today.
Online Financial Reporting Course–Only Two Weeks Left for Early-Bird Rate There are only two weeks left to receive the early-bird rate for the NASPP’s newest online program, “Financial Reporting for Equity Compensation.” This multi-webcast course will help you become literate in all aspects of stock plan accounting, including the practical considerations and technical aspects of the underlying principles. Register by April 29 for the early-bird rate.
NASPP “To Do” List We have so much going on here at the NASPP that it can be hard to keep track of it all, so I keep an ongoing “to do” list for you here in my blog.
Register for 19th Annual NASPP Conference (November 1-4 in San Francisco). Don’t wait; the early-bird rate is only available until May 13.
Register for the NASPP’s online Stock Plan Fundamentals program. Don’t wait–the course started last Thursday, but all webcasts are archived for you to listen to at your convenience.
It looks like hope of being the next Randall Heron and Erik Lie (of the options backdating study fame) remains alive in the world of academia. Three studies relating to stock compensation have recently been published.
This study looks for patterns in decisions to exclude stock compensation expense from non-GAAP earnings and earnings forecasts.
Somewhat predictably, the study finds that companies exclude stock compensation expense from non-GAAP earnings when doing so presents a more positive financial picture of the company to investors (e.g., increases or smoothes earnings, or helps the company achieve earnings benchmarks). Financial analysts, however, exclude stock compensation expense from earnings forecasts when doing so helps them to better predict future earnings performance. Hmmm, now that I’ve written this, it seems hard to believe a 52-page study was needed to figure this out.
In a nice counterpoint to the study “Employee Stock Options and Future Firm Performance: Evidence from Option Repricings,” that I blogged about in August (“Repricing and Company Performance,” August 31, 2010), this study finds that companies with broad-based options programs have better operating performance (based on return on assets), at least in smaller companies and in companies with higher growth opportunities per employee. The authors believe that options encourage cooperation and mutual monitoring among employees and may also serve to attract and retain higher quality employees.
This study looks at whether executives that exercise their stock options on the vesting date are motivated to do so by confidential information they have about the company. The study concludes that vesting date exercises are more likely motivated by the executive’s need to diversify his/her portfolio.
Time Has Run Out! All NASPP memberships expire on a calendar-year basis–if you haven’t already, renew your membership for 2011 today.
Got Questions on Section 16? Alan Dye has the answers. Email your burning Section 16 questions to adye@section16.net and Alan will answer them during his popular, annual Q&A webcast on Section 16. This year’s webcast will be held on January 25; this is your one chance all year to get answers from one of the nation’s foremost authorities on Section 16–don’t miss it!
NASPP “To Do” List We have so much going on here at the NASPP that it can be hard to keep track of it all, so I keep an ongoing “to do” list for you here in my blog.
The Boston NASPP chapter wins the race to have the first chapter meeting of the year! If you are in the Boston area, don’t miss the meeting on January 14.
Repricing and option exchange programs have long been a controversial practice. A study released earlier this year looks at whether repricings boost company performance.
The Repricing Controversy In the NASPP’s 2010 Stock Plan Design Survey, although 61% of respondents indicated that more than 50% of their options had been underwater in the past two years, only 7% had repriced (another 4% exchanged underwater options for full value awards, cash, or a combination of stock and options). Critics argue that repricing underwater options rewards employees for poor performance while proponents counter that repricing is necessary to retain employees and motivate future performance.
Repricing and Company Performance Studied
The study, “Employee Stock Options and Future Firm Performance: Evidence from Option Repricings,” co-authored by Ron Kasznik of Stanford University’s Graduate School of Business, Nicole Bastian Johnson of the Haas School of Business at UC Berkeley, and David Aboody of UCLA’s Anderson School of Management, looked at over 1,300 companies whose stock had declined by 30% or more annually from 1990 to 1996. Approximately 22% of those companies repriced; the study compared the performance of companies that repriced to those that didn’t.
Overall, the study found that the companies that repriced performed better over one, three, and five years. More specifically, the study found that companies that repriced only options held by executives outperformed the companies that did not reprice. On the other hand, companies that repriced only options held by non-executives did not outperform the companies that did not reprice.
Broad Implications for Stock Options
The authors hypothesize that this indicates that granting options to rank-and-file employees doesn’t enhance company performance. I haven’t read the whole study (not because I’m lazy–although that’s certainly a contributing factor–but because I can’t seem to access a copy of it for a nominal cost and, given how inscrutable the last study I blogged about turned out to be–see my August 18 entry, “Section 6039 and the Recession,” I’m not willing to make much of an investment here), but, according to the abstract, the authors assumed that once the options were underwater, any incentive effect they were having disappeared and that repricing the options would restore this incentive. If company performance didn’t improve after the repricing, I guess (emphasis on “guess,” as the reasoning that led to the conclusion isn’t clear from the abstract) the authors assumed that the options weren’t creating any incentive to begin with.
I Have Some Doubts
I’m not sure I’d make that leap–granted, I know next to nothing about conducting studies like this, but it seems to me that if you’re going to argue a point about the incentive effect of stock options, you ought to include some companies that don’t grant options as a control in the study.
It also seems like there are any number of other reasons why the repricings might not have improved company performance. For example, the rank-and-file employees could have lost faith in the options as a result of their being underwater and, while the repricing may have fixed the immediate tangible problem of the options being underwater, it may not have done anything to address the larger intangible issue of employees no longer believing in the company’s future growth potential. While this would impact the incentive effect of the repriced options, it doesn’t necessarily mean the options weren’t having an incentive effect before they were underwater. Or employees could be anticipating future repricings if the stock price declines further. Or, an even simpler explanation could be that the repriced options didn’t remain in-the-money–it isn’t clear from the survey abstract that the authors considered this.
The study also doesn’t say anything about retention–one of the primary reasons companies cite for undertaking repricings and option exchange programs. Valuation specialists have told me that in-the-moneyness is an important factor in estimating expected forfeitures, which leads me to believe that repricings could have their intended impact when it comes to retention.
Moreover, I’ve got to believe that the number of companies that repriced options held by executives only is a pretty small sample. Seriously, who does this? So I wonder how meaningful that data is.
Finally, what about the companies that repriced both executive and non-executive options? How did they perform?
Just 20 Days Until the 18th Annual NASPP Conference The 18th Annual NASPP Conference is less than three weeks away (and the hotel is already sold out)! Register today for the Conference, which will be held from September 20-23 in Chicago. I hope to see you there!
Last Chance for NASPP New Member Referral Program The NASPP’s New Member Referral Program ends this Friday, September 3. Any members you refer that join by this Friday receive 50% off their NASPP membership and you get $150 off your NASPP Conference registration (and an entry in our raffle for an iPad). Don’t wait–all memberships have to be completed by this Friday to qualify.
NASPP “To Do” List We have so much going on here at the NASPP that it can be hard to keep track of it all, so I keep an ongoing “to do” list for you here in my blog.
We have a lot of great new content on our NASPP site! I want to take the opportunity this week to let you know about some of the new features.
First, we have a new Quick Survey out on Global Stock Plans. Don’t forget to take a moment and complete this survey! It’s your opportunity to find out how other companies are dealing with some of the more difficult issues with global stock plans.
New Portals:
The NASPP portals provide a way to find consolidated information on the issues that matter most in stock plan management. Today, we have 26 portals listed; expect to see more in the future! You can access the NASPP portals from the list on the lower left side of the homepage, or through the drop-down menu on the navigation bar at the top of the site. The newest additions to our list of portals are:
Incentive Stock Options: Need a quick reference on the grant requirements for ISOs? Want to find the latest on Section 6039 Information Statements? The Incentive Stock Options portal not only has the comprehensive NASPP article on ISOs, it has final ISO regulations, articles, surveys, and sample documents.
Say on Pay: The Treasury, Congress, and the SEC have all proposed some form of say on pay requirements for companies. Our new Say on Pay Portal contains the proposed regulations along with memos and analysis on each. You can also find sample proxy statements from companies that have already taken steps to add a shareholder vote on compensation practices.
Surveys & Studies: I’m sure you all know that the NASPP publishes all Quick Survey, Stock Plan Design and Administration Survey, and Salary Survey results in the Surveys section of the Member Area drop-down menu on the navigation bar. But, did you know that we also have available comprehensive surveys and studies conducted by some of the best names in the industry? We’ve put them all together for you in our new Surveys & Studies portal. We’ve arranged this portal in a three-tab format so that you can find the study or survey you’re looking for by topic, year produced, or by the company publishing the information.
Updated Portals:
In addition to adding new portals, we’ve also gone back and reorganized some of our existing ones so that new developments and content are easier to find. Check out the updated 409A/Deferred Compensation portals and Executive Compensation Disclosures portal!
New content:
Our latest alerts on stock plan management practices, legislative and regulatory development, and global stock plans are always available on the NASPP homepage as well the corresponding portal. These are a few of the most recent additions:
There have been a lot of changes in global stock plan management. Don’t get left behind; sign up to have the latest alerts from specific countries send directly to your e-mail. In the past month alone, we’ve posted multiple alerts on Australia, the European Union, Portugal, Ireland, India and China. Don’t forget that you can search our global stock plan alert archives by country.
We’re not done, yet! You won’t want to miss out on what we have in store for next year. Renew your NASPP membership for 2010. If you aren’t an NASPP member, take advantage of our special offer and join today!