Capitol Observations, The Corporate World - Written by Beasley Allen on Wednesday, October 4, 2006 12:00 - 0 Comments

The Costs Of The Stock Options Scandal Are Very High

A new study estimates that the stock options backdating scandal may cost shareholders hundreds of millions of dollars. The study was released as two United States Senate committee hearings started to examine the scope of the widening investigation into improper practices relating to options. It appears from the study that backdating stock options between 2000 and 2004 helped to significantly increase the average executive’s pay by about $600,000 annually. It should be noted that the fallout from the recent options investigations has caused the companies run by those executives to fall in market value by an average of 8% – about $500 million each. The study concludes that “for about $600,000 a year to the executives, shareholders are being put at risk to the tune of $500 million.” That’s a pretty stiff blow to folks who have invested their money in these companies.

The report from the study will be published in The Michigan Law Review next year. It’s to be the first study to put dollar figures on the costs and benefits of backdating. The researchers at the University of Michigan 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. Dr. H. Nejat Seyhun, a University of Michigan finance professor who is one of the study’s co-authors, stated:

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. There may be additional payouts for class action lawsuits as well as worrying about the quality of the top management.

The study comes as the stock option scandal continues to grow and spread. More than 100 companies are now either under investigation by the federal government or are conducting their own internal reviews. Dozens of companies are working to restate earnings. Others are preparing for new tax bills. In at least two cases, company executives are facing criminal charges. The Senate Banking Committee and the Senate Finance Committee are now looking into the scandal. Members of these committees were briefed on recent developments by top government officials and corporate governance experts.

Congress should take steps to curb excessive executive pay of public companies when wrongdoing is involved. Some estimate that options backdating could have occurred at hundreds of public companies and that it resulted in illicit gains in the billions of dollars. If this is true, Congress must get involved. Other issues related to executive pay, like golden parachutes, should also be addressed. But Congress’s track record on the options issue has been spotty at best. Lawmakers appear to be reluctant to interfere with private sector pay levels. Past efforts at reform have been inadequate, or at least that seems to be the case. I suspect Congress’ failure to take real tough action is tied more to campaign funds than to anything else.

Source: New York Times