NY Times article on options repricing by ASND and other companies
nytimes.com
July 15, 1998
MARKET PLACE
If the Price Isn't Right, Just Change It
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By DAVID CAY JOHNSTON
n October, when shares of Ascend Communications had fallen
below $36 from a high of $80.25 just 90 days earlier, the board
quietly gave employees a sizable gift, slashing prices on tens of millions
of stock options they held.
A month later after the stock had fallen below $23, Ascend, a
telecommunications network equipment maker in Alameda, Calif., did it
again, although this may come as news to shareholders. It was only
disclosed six months later, in the 12th footnote to a series of financial
tables the company filed with the Securities and Exchange Commission.
These maneuvers shifted about $1 billion in equity from investors to
employees, who on average ended up more than $600,000 richer, the
Wisconsin Investment Board estimated.
Ascend is not alone. This type of tinkering with what was supposed to
be a reward for a job well done is on the rise -- and is causing growing
controversy. Research by academics and compensation consultants
now shows that it is much more common than even the critics had
thought.
Increasingly over the last decade, stock options have become an
essential part of a corporate pay package. Now, at a growing number
of companies, particularly in technology, they are moving beyond the
executive suite -- often to everyone down to the janitor.
Giving employees the right to buy their employer's stock for a set price,
no matter how high the stock rises, is supposed to give workers a
powerful incentive to pull together to lift a company's fortunes -- and
thus the return to shareholders.
And as the stock market has soared, options have indeed showered
wealth on countless people -- even if their employers' stock has been
propelled as much by Wall Street euphoria as by their own hard work.
But what of companies that stumble, even in boom times? Say an
employee is given the right to buy a company's stock for $20 a share --
and counts on a nice windfall from those options as part of total pay. If
the stock slumps to $15, and stays there, the option is worthless.
One solution that is growing in popularity: simply "reprice" the option. If
that "strike price" drops from $20 to $10, the employee is suddenly in
the money again at $15 a share.
Like all options, though, that money dilutes the stake of outside
investors, and the biggest of them -- institutional investors like pension
funds -- are not happy about it.
In their defense, many companies -- especially high-technology
concerns -- say they will lose talented people if they cannot dangle
potentially lucrative options in front of them. "The only good argument I
have heard for repricing is to address a potential turnover," said Yale
Tauber, a compensation expert at William H. Mercer, pay consultants.
"The currency they deal in, especially in Silicon Valley, is options."
If they lose key employees just as they are preparing to bring a new
product or service to market, companies insist, it can spell ruin for
investors, while keeping those people brings the prospect of more
revenues and higher share prices.
Moreover, other experts defend stock options as an appropriate
reward for employees who commit their time and careers to a
company, while investors can far more easily move their money
elsewhere if things go wrong.
The fact is, though, that higher share prices do not necessarily follow
when the options bar is lowered. "After option repricings, share prices
move in a random walk," said David Yermack, associate professor of
finance at New York University's Stern School of Business.
And new data show that once companies reprice options, there is a
good chance they will do it again, becoming serial repricers.
As for large companies, like those making up the Standard & Poor's
500-stock index, perhaps one a year reprices executive options. But at
midsize companies, slightly more than 1.2 percent of options held by
executives are repriced each year, Yermack found in his latest study.
Repricing, he found, is even more common among smaller companies,
with 2 percent of executives' options repriced annually from 1992
through 1995.
Yermack said that before starting his research, "I thought that the rate
of repricing was close to zero and a few anecdotal examples just made
for inflammatory news stories. I thought that because most of my work
was with Fortune 500 and S&P 500 firms.
"But working with data from smaller companies, you find much higher
rates of repricing," he said, "much higher than my colleagues and I
would have expected, especially with the bull market."
He also found that when options are repriced, the period to exercise
them is often extended. If, for example, a 10-year option with three
years left to run is both repriced and extended for 10 years, it
becomes, in effect, a deeply discounted 17-year option.
Yermack's findings understate the situation because he limited his
research to executives. Companies like Ascend, which repriced options
for everyone except officers named in proxy statements, were excluded
from his study.
SEC rules require detailed disclosure in proxy statements, which are
mailed to all shareholders, when a repricing occurs on options granted
to the chief executive and other named executives.
But if the executives are excluded, these rules do not apply, even
though the cost to outside shareholders may be much greater. At
Ascend, for example, the rank and file combined held eight times as
many options as the combined holdings of Mory Ejabat, the chief
executive, and the other four named executives.
While the five executives did not have their options repriced, they were
granted 712,000 new options, all at prices below the lowest repriced
options for other employees.
Other research shows that companies like Ascend, which repriced
options twice last year, have a good chance of doing it again. Mercer
found 50 companies that repriced options at least twice in the last
decade. Of these, 16 repriced options three or more times.
Ramsay Health Care of Coral Gables, Fla., repriced options five times
from 1991 to 1995, Mercer's research showed, from a peak of $14.13
to a low of $2.50. The stock now trades at $2.25.
Isa Diaz, a Ramsay spokeswoman, said that the five repricings were
under previous management but that the new management believes
repricing "can be a tool when trying to correct or bring fair-market
value to pricing" so options remain an incentive for executives.
Graef Crystal, a noted critic of high pay for executives, said companies
may feel they have no choice but to reprice options when recruiters tell
their most valuable workers, "Join our company, and you can have
options at street level, not five sub-basements beneath the street."
Since companies that reprice are already in trouble, it should be no
surprise that some continue to be in trouble and their stocks keep
sinking, said Donald Chance, a finance professor at Virginia Tech who
has also studied option repricings.
The value of Cypress Semiconductor shares improved after it repriced
options in 1990 and 1992, but in 1996 share prices fell. Despite two
more repricings, they have not recovered. Flagstar, the restaurant
operator controlled by Kohlberg Kravis Roberts & Co., slid into
bankruptcy despite three option repricings between 1992 and 1995.
The volatility of stock prices of high-technology companies can also
lead to manipulation, Chance said. And the result, he added, "is a lot of
money to the executives, but not much to shareholders, overall."
No academic research has been published on the impact of repricing
broadly based options, like the Ascend repricing. Studying such
repricings would be difficult because SEC rules do not require much
disclosure, as long as the executives named in proxy statements are
excluded.
The Ascend repricings were disclosed in May, deep in its annual 10-K
filing with the SEC, a dense document that few shareholders or even
professional investment advisers plow through.
The footnote did not give a reason for the repricings, their costs or any
potential benefits to shareholders.
Ascend repeatedly refused to talk about it. "We regard this as a private
matter," said Eric Warren, a spokesman for the company, whose
shares trade on the Nasdaq.
Because of the way the footnote is written, it is not even clear how
many Ascend shares were repriced or whether both repricings affected
all employees or whether the separate actions were aimed at different
groups of options holders.
It shows that 35 million options were canceled, but several
executive-compensation experts said they could not calculate precisely
how many were repriced, because of the way the company presented
the data.
Analysts who follow the company said the options were repriced to
keep engineers and salespeople from bolting to rivals like Cisco
Systems, 3-Com and Bay Networks.
Other footnotes in its reports suggest how eager Ascend is to hold onto
employees, if only for an extra few weeks. While options typically vest
over a period of years -- 20 percent a year, perhaps, for five years --
the Ascend options vest over four years, at the rate of one-forty-eighth
a month.
The limited information in the footnote suggests that the company used
the repricing to sweeten its stock-option offerings even more than just
lowering the price would have indicated.
Some options were issued at $113.04 each, the footnote states, well
above the $80.25 a share at which Ascend shares peaked a year ago.
This suggests that some options were issued at premium prices, as
much as 41 percent above the top market price.
Most options are priced at the trading price on the day they are
awarded and run for five or 10 years.
Sometimes options are priced at a premium to the market so that share
prices must rise before any money can be made on them. A growing
number of big institutional shareholders favor premium pricing because
it ensures that investors make some money before employees and
executives do.
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