Jacob- The good
Still, there may be a ray of sunshine here. Earlier research I have undertaken
shows that if you could buy a company's shares the very day a repricing
occurred, you would, more often than not, earn a superior future return -- at least
for the next six to 12 months. CEOs seemingly have noses like truffle hounds
when it comes to sniffing out their company's market lows.
and the bad:
Many corporate governance experts would be quick to tell you that there isn't
much worse than an option repricing. Well, they'd be wrong. In the long run, what
Microsoft has gone and done is worse.
Microsoft Avoids Option Repricing
By Graef Crystal
(Commentary. Graef Crystal is a columnist for Bloomberg News. The opinions
expressed are his own.)
bloomberg.com
San Diego, April 26 (Bloomberg) -- Nobody ever said Microsoft Corp. wasn't
creative.
The software maker has found a nice way to avoid the mess of repricing
employee stock options that are underwater. Simply give every employee a
brand new option grant and let him or her keep the earlier grants. That way the
company sidesteps having to take on the accounting cost of lowering the strike
price, not to mention the foul smell that accompanies an option repricing.
That is what Microsoft has done. The company said yesterday it doubled
annual stock option grants to all its 34,000 full-time employees following a 43
percent decline in its stock this year through Monday. Nothing is free in this
world, and those options expose shareholders to the risk of either dilution from
the new shares ora cash drain from buying back stock to avoid increasing the
number of shares outstanding.
Microsoft typically grants its employees stock options in July of each year.
Options on about 70 million shares were issued last July and again on Monday.
Out of the Money
The options granted last July are seriously out of the money today. Microsoft's
average closing price during July 1999 was $92.11 a share, with a range from 85
13/16 to 99 7/16 a share. Yesterday the stock closed at 69 3/8.
To keep employees from looking for jobs elsewhere, the company decided to
make a second grant, the first time it had done so in one fiscal year. Employees
were given grants equal to the number of shares they had been granted last
July, but with a strike price of 66 5/8 a share, Monday's closing price.
A more common way of handling a stock price decline in a high- tech firm is to
do a repricing. In that situation, employees would be asked to bring in their
optionagreements of last July. Then, on, say, page 3, where the agreement
says: ``To exercise this option, you shall pay the company $92.11 a share,'' the
company would erase the $92.11 figure, put in a new figure of 66 5/8 and hand
the agreement back to the employee.
Option repricings have been roundly condemned by virtually all corporate
governance experts. They are, after all, a way of allowing an optionee to play
tennis with the net down, thereby making it exceedingly difficult for him to miss a
shot.
Some companies have made a veritable specialty of option repricings, with the
number reaching eight or more at Apple Computer Inc. and Integrated Device
Technology Inc. At such companies, page 3 of the option agreements has to be
printed on 500-pound paper to withstand the frequent erasures.
New Rules on Repricings
Confronted with a massive slump in its stock price, the option repricing route
might seem a natural for Microsoft. But the environment forrepricings has
changed dramatically in recent months due to a ruling expected soon by the
Financial Accounting Standards Board.
That ruling, which promises to be retroactive to December 1998, would subject a
company to potentially massive charges to earnings if it reprices stock options.
Let's assume Microsoft last July issued 70 million option shares carrying a strike
price of $92.11 a share. Suppose the company repriced those 70 million shares
on April 24, dropping the strike price from $92.11 a share to 66 5/8. Finally,
assume Microsoft's market price rebounds and that, some years into the future,
the employees exercise their 70 million shares at a time when the market price
per share was 300.
Under the expected new FASB rules, Microsoft would have to charge its
earnings with the gain of 233 3/8 a share multiplied by the 70 million shares
granted, or a whopping $16 billion. Accruals would have to be taken all during
the period between the date of repricing and the date of exercise. (For normal
options, no such charges to earnings ever need be taken.)
Dilution or Cash Drain
What to do? If Microsoft did nothing, it would likely lose a good many talented
employees. After all, they could cross the street, as it were, and get new stock
options carrying a strike price that was equal to their new employer's current
market price. So why would they want to stick around at Microsoft and light
votive candles, praying for a resurgence in the stock price?
On the other hand, if Microsoft repriced, there would be those wild charges to
earnings.
Microsoft's alternate strategy would seem a way to avoid the charge to earnings
and yet provide talented employees with new holding power to keep them from
departing.
The only problem with this alternative is that it exposes Microsoft's shareholders
to a double dose of dilution. If the company's stock price rises from 66 5/8 to
$92.11 a share, the new stock options will take on value, and the company's
diluted earnings per share will start declining unless the company shells out
hard cash to buy back shares to match each option exercised.
Then if the stock rises above $92.11 a share, a turbocharger will kick in, and the
options granted last July also will take on value and cause further dilution in the
company's earnings per share or a further cash drain for buybacks.
The Bottom?
Many corporate governance experts would be quick to tell you that there isn't
much worse than an option repricing. Well, they'd be wrong. In the long run, what
Microsoft has gone and done is worse.
Still, there may be a ray of sunshine here. Earlier research I have undertaken
shows that if you could buy a company's shares the very day a repricing
occurred, you would, more often than not, earn a superior future return -- at least
for the next six to 12 months. CEOs seemingly have noses like truffle hounds
when it comes to sniffing out their company's market lows.
Perhaps that is why Microsoft stock rose 4.1 percent yesterday following the
new option grants. |
