Chuz, your criticisms of options accounting - and the abuses that have followed, are 100% on target.
The WSJ had a front page article last week detailing a particularly egregious case of excessive amounts of options being granted. The case involved Henry Silverman, the CEO of Cendant. What really stands out are the numerous instances in which Cendant's Board would change the rules in the middle of the game. For example, in 1996 the Board made all of Silverman's options immediately exercisable - scrapping a 5-year vesting rule that the company had always followed previously. I believe that's just the kind of abuse you have complained about, since options can hardly provide incentives after they have been exercised! Here is the story in case anyone is interested.
The Wall Street Journal Interactive Edition -- July 17, 1998
Cendant CEO's Massive Wealth
Melts With Drop of Share Price
By MARK MAREMONT
Staff Reporter of THE WALL STREET JOURNAL
How does it feel to lose nearly $1 billion in three months? Ask Henry R. Silverman.
In early April, the chief executive of Cendant Corp. was sitting on more than 46 million stock options, with a paper value of almost $1.2 billion. By any measure, it was one of the largest options positions ever amassed, far outstripping those of such noted options kingpins as Walt Disney Co.'s Michael Eisner and Sanford Weill of Travelers Group Inc. But with the recent meltdown of Cendant's stock price after revelations of widespread accounting fraud at its CUC International unit, Mr. Silverman suddenly has turned into a relative pauper. His options now are worth about $250 million. "I can tell you, it doesn't feel good," Mr. Silverman says.
Winning Negotiations
Don't feel too sorry for him, though. To build his enviable options holdings, the 57-year-old tax attorney-turned-dealmaker deftly negotiated and renegotiated ever-richer options packages with his boards of directors. In one unusual decision, the board of HFS Inc. -- which Mr. Silverman ran and merged into CUC to form Cendant late last year -- canceled a provision that would have required him to wait several years to exercise millions of options. It was deals like that that helped give Mr. Silverman 11% of HFS shares at the time of the merger with CUC.
Mr. Silverman's directors "definitely have been very generous," says Carol Bowie, director of research at Executive Compensation Advisory Services, a Springfield, Va., company that tracks executive pay. "It's unusual for any corporation to feed the CEO that amount of equity." Few large companies grant options covering more than 10% of their shares to all executives combined.
For his part, Mr. Silverman says he "worked his tail off," in running the company and has created "enormous value for shareholders." And Robert F. Smith, an outside director who has headed the compensation committees of both HFS and Cendant since 1993, says Mr. Silverman deserved all of his options. He calls the Cendant CEO "one of the best financial managers I have ever seen," and says he believes people producing superb results should be compensated accordingly.
Mr. Silverman's initial options date back to the formation of HFS in the early 1990s. Then a partner of Blackstone Group, a New York private-equity firm, he hatched a plan to create a hotel-franchising company by acquiring the Ramada, Howard Johnson's and Days Inn brands. Mr. Silverman became the chief executive of the newly formed company, and Blackstone gave him options as an incentive.
The initial options, amounting to about 6% of HFS stock, had tough provisions. They would vest in portions over five years, and the strike price -- the price Mr. Silverman would have to pay to exercise them -- would rise 9% per year. Some corporate governance experts like such "indexed" options, because they don't reward executives for stock that rises with the market.
Helpful Changes
Blackstone sold its stake in 1993, and Mr. Silverman stayed on. Soon after, the board retroactively changed the 9% indexing feature of the options in Mr. Silverman's favor, so that the option strike price ceased to rise for a tranche once it vested. Mr. Smith says the board relied on outside compensation experts, who said the indexing feature was "not normal" for a public company.
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Easy Come, Easy Go
The rise and fall of Henry Silverman's stock options:
Millions
1992 $11
1993 56
1994 58
1995 330
1996 554
1997 883
1998
April 6*
July 16
1,160
250
Note: Year-end value of unexercised options
*Stock's high
Source: Cendant Corp.
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Over the next few years, Mr. Silverman received annual options grants whose size increased rapidly. The options awards grew to 4.4 million in 1995 from 2.8 million in 1993. (All share amounts are adjusted for splits and the Cendant merger.)
The 1995 grant amounted to nearly 2% of HFS's outstanding shares, a larger percentage than given to most high-profile CEOs, compensation experts say. By contrast, over the last six years Mr. Eisner has received the options equivalent of just over 1% of Disney's stock, all of it in his celebrated 1996 grant of eight million options.
In 1996, Mr. Silverman signed a new employment contract with HFS, a blockbuster containing several unusual provisions. For starters, the board retroactively made all of Mr. Silverman's options immediately exercisable -- with the stroke of a pen doing away with the five-year vesting schedule HFS had followed since its founding.
More than 12 million of Mr. Silverman's options -- half the total he then controlled and with an indicated value of $155 million -- still hadn't become exercisable as of the beginning of that year. But under the new contract, they were.
The board also guaranteed that Mr. Silverman would receive 4.8 million options each year from 1996 to 2000 -- at the time equivalent to 10% of HFS's shares outstanding in total. Should HFS have a "change of control," Mr. Silverman would immediately get the options that hadn't yet been granted. If it were a cash transaction, he would get the cash equivalent of their value.
Unusual Move
That also was unusual: Several compensation experts say it is standard in a takeover for executives immediately to get options that have yet to be vested, but they had rarely heard of an executive getting options that had yet to be granted.
Observers at the time speculated the board gave Mr. Silverman such a generous package because he was thinking about jumping ship. But both Messrs. Silverman and Smith say that wasn't so. "We were convinced that Henry was going to stay with the company," says Mr. Smith. Instead, Mr. Smith says, Mr. Silverman had told the board he was planning to exercise some of his many options and then sell the shares, which the board was concerned would be a bad signal for investors.
In exchange for the new multiyear option package, Mr. Smith says, Mr. Silverman agreed to limit his sales of stock to 4.8 million shares per year. And the reason the board retroactively made Mr. Silverman's prior options immediately vested was to increase his visible stake in the company and reassure investors of his commitment to HFS, Mr. Smith says. Also, he says, any sales of stock by Mr. Silverman would seem like a smaller percentage of his now-larger holdings, again reassuring investors.
Mr. Silverman says he agrees with Mr. Smith's account but can't recall whether these provisions were his idea or the board's.
In early 1997, after Mr. Silverman held initial talks with CUC about a merger, the board again changed Mr. Silverman's contract. This time, in the event HFS was acquired in a stock transaction, Mr. Silverman was guaranteed a lump-sum payment for his as-yet-ungranted options, potentially hundreds of millions of dollars. Mr. Silverman says the CUC talks broke off before that point, but that HFS's board believed the company might be a target for acquisition, and "felt I should not be disadvantaged" by a clause that limited his payout in an all-stock deal.
Four months later, an all-stock deal emerged: the HFS-CUC transaction. The companies were of equal size, but with CUC as the acquirer, the deal triggered the change of control provision, theoretically entitling Mr. Silverman to the hefty payout, valued at $250 million. Even so, Mr. Silverman would remain CEO of the merged company.
Mr. Silverman says he offered to convert those options into the equivalent number of Cendant options, 14.5 million options in total. "I felt it was inappropriate to tell the shareholders to do this deal, but by the way, I'm going to take $250 million off the table," Mr. Silverman says. The Cendant chief says he also wanted options because he felt optimistic about the merged company's future. Once again, the board acceded to this change.
In hindsight, Mr. Silverman says, his decision looks "stupid." Cendant's stock, which rocketed to more $41 a share in early April, is now below $15 a share. His newly minted 14.5 million options, with a strike price of $31.375, are far under water.
But Mr. Silverman is still sitting on a fair-sized options trove. And over the past two years, he has cashed in options netting him about $106 million. Many were exercised early this year before the CUC accounting problems were uncovered. Mr. Silverman also says he was given another 1.7 million Cendant options earlier this year. Those, too, are out of the money.
Copyright c 1998 Dow Jones & Company, Inc. All Rights Reserved.
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