Executive stock options (ESOs) are used to provide incentives for executives to improve company performance. ESOs are usually granted “at-the-money,” meaning that the exercise price of the options is...

Stock,options,are,promoted,by,their,supporters,as,the,most,effective,way,to,align,executive,and,e
mployee,interests,with,those,of,shareholders.,They,are,supposed,to,transform,executives,from,fly
-by-
night,plunderers,in,the,mold,of,former,Tyco,or,WorldCom,executives,into,rational,leaders,who,
make,prudent,,long-term-oriented,decisions,with,shareholder,capital.
But,are,options,really,as,great,for,all,parties,as,many,have,assumed?,The,stock,option,�backdati
ng�,scandal,has,implicated,several,(mostly,technology),companies,over,the,past,few,months.,T
he,SEC,and,other,federal,authorities,are,cu
ently,investigating,more,than,50,companies,suspecte
d,of,illegal,,undisclosed,options,backdating,practices,,and,the,first,criminal,charges,relating,to,th
ese,practices,are,expected,shortly.
The,practice,of,backdating,options,is,not,illegal,as,long,as,it,is,disclosed,to,shareholders.,This,fa
ct,is,often,used,as,a,reason,to,downplay,the,seriousness,of,the,issue.,You�d,think,that,sharehold
ers,wouldn�t,tolerate,the,use,of,accounting,sleight,of,hand,to,compensate,executives,while,byp
assing,the,traditional,�selling,,general,,and,administrative�,line,in,the,income,statement.,But,a
use,of,stock,options,has,been,allowed,to,perpetuate,for,years.,In,all,my,reading,of,the,backdatin
g,scandal,coverage,,I,have,yet,to,see,a,thorough,analysis,of,the,real,victims,of,this,scandal:,share
holders.
Simply,put,,backdating,a,stock,option,grant,amounts,to,ripping,off,shareholders,by,shortchangin
g,the,company,treasury.,Shares,are,issued,to,option,holders,at,artificially,low,prices,and,the,com
pany,gets,an,artificially,low,amount,of,capital,in,return,for,its,shares.,Backdating,is,perpetrated,
y,�che
y-
picking,�,after,the,fact,,the,lowest,points,the,company,stock,traded,throughout,the,previous,yea
,when,calculating,the,exercise,price,of,option,grants.
The,exercise,price,of,an,option,is,crucial,because,it,is,the,price,the,executive,or,employee,option,
holder,must,pay,to,the,company,when,exercising,options,in,return,for,newly,issued,shares.,If,the,
exercise,price,were,$0,,then,options,would,be,nothing,more,than,free,stock,grants,,and,treated,as
,such,in,the,eyes,of,recipients.
But,the,great,majority,of,public,companies,issue,options,with,an,exercise,price,equal,to,the,mark
et,price,at,the,date,of,grant.,This,practice,requires,at,least,a,nominal,investment,on,the,part,of,the
,option,holder,if,he,or,she,wishes,to,exercise.,The,CEO�s,conflict,of,interest,between,short-
term,personal,wealth,maximization,and,long-
term,shareholder,interests,tends,to,tilt,in,the,shareholders�,favor.
Backdating,Options:,Compensation,Committee,Looks,out,for,Executives
But,long-
term,executive/shareholder,interest,alignment,gets,thrown,out,the,window,when,unforeseen,circ
umstances,cause,a,temporary,crash,in,a,company�s,stock.,Executives,can,profit,quickly,at,share
holders�,expense,in,such,instances.,Instead,of,using,excess,cash,to,buy,back,stock,at,a,short-
term,discount,,a,long,list,of,blue,chip,companies,used,the,post-
Sept.,11,market,decline,to,dilute,shareholders.,A,recent,Wall,Street,Journal,article,entitled,�Exe
cutive,Pay:,The,9/11,Factor,�,describes,the,sequence,of,events,(my,emphases):
�A,Wall,Street,Journal,analysis,shows,how,some,companies,rushed,,amid,the,post-
9/11,stock,market,decline,,to,give,executives,especially,valuable,options.,A,review,of,Standard,
&,Poor�s,ExecuComp,data,for,1,800,leading,companies,indicates,that,from,Sept.,17,,2001,,thro
ugh,the,end,of,the,month,,511,top,executives,at,186,of,these,companies,got,stock,option,grants.,
The,number,who,received,grants,was,2.6,times,as,many,as,in,the,same,stretch,of,September,in,2
000,,and,more,than,twice,as,many,as,in,the,like,period,in,any,other,year,between,1999-2003.
�Ninety-
one,companies,that,didn�t,regularly,grant,stock,options,in,September,did,so,in,the,first,two,wee
ks,of,trading,after,the,te
or,attack.,Their,grants,were,concentrated,around,Sept.,21,,when,the,ma
ket,reached,its,post-
attack,low.,They,were,worth,about,$325,million,when,granted,,based,on,a,standard,method,of,va
luing,stock,options.
�The,91,companies,included,such,corporate,icons,as,Home,Depot,Inc.,,Black,&,Decker,Corp.,,
and,UnitedHealth,Group,Inc�.�
The,mind-
set,of,Stryker�s,compensation,committee,stands,out,as,the,least,shareholder,friendly,among,this
,article�s,list,of,blue,chip,companies:
�At,Stryker,Corp.,,a,Michigan,maker,of,orthopedic,products,,onetime,stock,option,committee,
member,John,Lillard,said,he,didn�t,regret,the,decision,to,award,options,nine,days,after,the,atta
ck.,�If,you,believe,the,company,is,going,to,do,well,,and,here,is,an,external,event,that,is,affectin
g,the,market,,and,you�ve,made,a,decision,to,reward,executives,,you,go,ahead,with,it,�,Mr.,Lil
lard,said.,�Life,goes,on.�,�
�At,Stryker�post-
9/11,stock,option,grants,to,several,executives,appear,to,have,been,initiated,by,the,chairman,and,
CEO,at,the,time,,John,W.,Brown.,They,were,dated,Sept.,20,,2001,,at,the,bottom,of,a,sharp,�V
�,pattern,in,the,share,price....