Executive Stock options – Corporate’s Shady Secrets

Over the last few years there have been some news coverage dealing with executive compensation with stock options. This type of compensation occurs when an executive is granted the "option" to purchase the company's stock at a certain price sometime in the future.

The theory is, if the executive is effective, his management skills will lead to a higher stock price. As a reward the executive can purchase the stock at the earlier, lower price and lock in an automatic gain in his shares. The problem lies with certain companies who have been falsifying important information dealing with such transactions.

It appears that the recent stories about executive stock options exist because there are so many ways it can go wrong. It is meant to motivate good executives to do better. However, use of stock options as compensation has led to the rash of communal fraud and abuse. Greedy executives hope to own large amounts of options and it causes many of them to take drastic steps. A good majority go as far as falsifying records. They do this to drive the stock price up so they could benefit by cashing in while the stock was artificially high.

The fear of executives taking advantage should sway corporations, but it seems that the government provides an additional benefit to keep it going. Providing the stock option gives a corporation the opportunity to take a tax deduction. The greedy executives can also take advantage of this and use loopholes in accounting rules to avoid counting them in financial statements when they are issued. This creates very misleading financial reports and additional savings for a corporation.

Companies that include stock options for high-paid employees seem to find more negative backlash in the news than they do benefits. It appears that executives will drive up stock value by altering the created date to match the date of the stock's lowest price. This allows an employee to benefit illicitly when exercising the purchase option.

Surprisingly, the practice of changing dates is not illegal, but defrauding the government is. Misrepresenting the options in official reports to shareholders, and the S.E.C (Securities and Exchange Commission) by understating the company's expenses and overstating its net income is a crime referred to as backpedaling. At least 50 companies have been investigated by the S.E.C for backpedaling on the dates of stock options. When there are falsified documents, the government views that as intent to defraud. It is a general rule that people do not normally falsify documents unless they are trying to hide something or portray something different from reality.

There is record of fraudulent activity all over. Even the major corporation Apple was recently put under a microscope when a recent sink in shares to as much as 6 percent due to misrepresented numbers. Though, they later recovered and were off only about 0.5 percent in afternoon trading.

One of the first CEOs to be prosecuted for the fraudulent accounting activities was Gregory Reyes, the former chief executive officer of Brocade Communications Systems in San Jose. The former Silicon Valley executive received a sentence of a year and nine months in prison and a $15 million fine. He was named in Time magazine 2007 “Top 10 crooked CEO’s”, (pictured below)


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The ethical ramifications of corporate fraud are great and many, causing a great many victims. If it is done enough, it can negatively affect the overall economy, employment, and, as seen with the much publicized Enron scandal, people's life savings. In an economy like ours trust is already eliminated and it is harder for the average Joe to spend money at a place he distrusts, which causes everyone to suffer.

Recently there have been some studies made into this type of fraud to prevent and understand it. A University of Iowa researcher, Erik Lie decided to study the difference of stocks prices before and after options grants. Lie did a massive study and recorded the transaction averages of thousands of option grants between two decades. In his report, Lie discovered that executives had to be backdating the stocks unless they were uniquely gifted to forecast precise market movements (he adds that the possibility of that happening are as likely as winning the lottery twice). In response to this problem, the SEC has established rules that make executives disclose their pay.

During this time of great scandals and fraudulent business activity a new accounting law came into effect. The Sarbanes-Oxley act requires that option grants be reported within two business days. This new law will also explain the new trend of “super packs” that have been taken up by people to hide their money. I personally feel that is we are going to work ourselves out of this economic depression we have to work together. I do not claim to have an answer for an easy fix because I do not believe there is one. I do, however, believe that the stock market should probably not be given as an executive option because the stock market is already a mess as it is.


References

J. Fox, (November 14 2006) Sleazy CEOs have even more options tricks. CNN Money:

http://money.cnn.com/2006/11/13/magazines/fortune/options_scandals.fortune/index.htm?postversion=2006111416

J. Grant (May 31 2006) Stock options under scrutiny. FT.COM http://www.ft.com/cms/s/2/88217da0-f0f2-11da-9338-0000779e2340.html#axzz1HIAiNu00

CNN Editors (December 27 2006) Apple sinks, then recovers after report. CNN Money. http://money.cnn.com/2006/12/27/technology/apple_options/index.htm

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Comments 1 comment

Gabby 22 months ago

That's really thinking at an imirvsspee level

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