Report Estimates the Costs of a Stock Options Scandal
September 6, 2006
By ERIC DASH
WASHINGTON, Sept. 5 — A new study estimates that the stock options backdating scandal may cost shareholders hundreds of millions of dollars. The study was released on the eve of two Senate committee hearings that plan to examine the scope of the widening investigation into improper options practices.
Three researchers at the University of Michigan estimated that backdating stock options between 2000 and 2004 helped sweeten the average executive’s pay by more than 1.25 percent, or about $600,000. But the fallout from the recent options investigations has caused those executives’ companies to fall in market value by an average of 8 percent, or $500 million each.
“For about $600,000 a year to the executives, shareholders are being put at risk to the tune of $500 million,” the study concludes.
The working paper, expected be made public later this week and to be published in The Michigan Law Review next year, appears to be the first to put dollar figures on the costs and benefits of backdating. It analyzed thousands of stock option grants at 48 companies that announced they were under investigation as of the end of June, and measured the maximum gains for those executives if their options were backdated over a 90-day period as well as the drop in value at those 48 companies in the 10 days before and after news of a backdating inquiry was released.
“From a shareholder’s perspective, it’s not just the extra compensation the executives got, it’s not just the extra taxes they have to pay,” said H. Nejat Seyhun, a University of Michigan finance professor who is one of the study’s co-authors. “There may be additional payouts for class-action lawsuits as well as worrying about the quality of the top management.”
As an economic analysis, the study assumed that investors’ calculations of those risks, not irrational panic, was responsible for the substantial stock market declines. The researchers also assumed that the stock prices of those 48 companies would not recover.
The study comes as the stock option scandal continues to widen. More than 100 companies, from Silicon Valley start-ups to prominent brands like Apple Computer are now either under investigation by the federal government or conducting their own internal reviews. Dozens of companies are working to restate earnings or are preparing for new tax bills, and in at least two cases, executives are facing criminal charges.
On Wednesday, members of the Senate Banking Committee and the Senate Finance Committee will be briefed on the scandal’s latest developments by top government officials and corporate governance experts in dueling sessions this morning on Capitol Hill. No company executives are scheduled to testify.
With just a few weeks until midterm elections, no new legislation is expected to emerge from the hearings. But the sessions could set the stage for Congress to revisit the hot-button issue of executive pay during the next term, policy makers and governance watchdogs say.
“This isn’t as tangible to people as Enron’s thievery was — it’s much more esoteric,” said Gregory P. Taxin, the chief executive of Glass, Lewis & Company, a proxy advisory firm. But if options backdating “is found to have occurred at hundreds of public companies to the tune of billions in illicit gains, Congress is going to see this as a populist issue.”
With close Congressional races ahead, the Senate panels have been set up in a way that allows lawmakers to score points with voters for closely monitoring executive pay. But they were not set up to investigate what, if anything, has gone wrong. No executives at companies involved in the backdating scandal were asked to testify. Nor was the Business Roundtable invited, despite being an influential chief executive lobbying arm.
“What you will see is a very clear message to the regulators to get cracking and enforce the law,” said Damon A. Silvers, associate general counsel of the A.F.L.-C.I.O.
Still, others added that the scandal may open the door for Congress to tackle broader issues related to executive pay, like golden parachutes. But Congress’s track record on the issue has been spotty at best, with lawmakers reluctant to interfere with private sector pay levels and unintended consequences overshadowing the benefits of past efforts at reform.
On Wednesday, the Senate Banking committee will be briefed on the options scandal by Christopher C. Cox, the chairman of the Securities and Exchange Commission, and Erik Lie, the University of Iowa finance professor whose statistical research is widely credited with identifying the improper grant practices.
The Senate Finance Committee, meanwhile, will discuss both the backdating scandal and a broad range of topics related to executive pay. Paul J. McNulty, the deputy United States attorney general; Linda Cutler Thomsen, the S.E.C.’s director of enforcement; and Mark W. Everson, the Internal Revenue commissioner, will testify about their agencies’ recent investigations.
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