Sunday, September 03, 2006
Backdating: A Further Response to Profs. Manne & Wright
Over at the Truth, Geoff Manne and Josh Wright have done me the pleasure of a graf-by-graf response to my original post on backdating. Unfortunately, I only saw their post after I responded to Larry Ribstein's post. Much of what I have to say in that response applies to the Manne & Wright missive. But I also wanted to add a few more thoughts.
- I'm not sure if part of what is going on here is a difference in the assumed fact pattern we're talking about. In at least some of the fact patterns, executives duped the board and/or the board's compensation committee through backdating. This case is much more clearly an example of the executives getting more than they would have gotten under market negotiating conditions. If the board and executives all conspire to backdate options, then you can argue it's a way of disguising the actual amount of compensation that both the board and the executives have agreed on. But of course, then they're lying to the market and to shareholders.
- Manne & Wright want you to believe there is no lie so strongly they're willing to say it in all caps -- "THERE IS NO LIE." But shouting doesn't make it so. It is clearly a lie -- the disclosure claims that the option was issued on a certain date, when it was not. M&W seem to think this makes it better than if the option had been actually issued on that date, but just disclosed late. But backdating is always a lie -- you are claiming something happened before it actually did. I am baffled that this basic conception can elude my esteemed interlocutors.
- M&W have fun with my mention of "norms" -- obviously, only a market-hating leftie would use such ridiculous language. But my use of the word norms was to talk about market norms. Yes, there is a market for executive talent, but it is not a prototypical example of arms-length bargaining. Boards rely heavily on what the market norms are -- namely, what other firms are paying their executives. They pay consultants lots of money to figure this out. Given stock volatility, I doubt compensation committees were scrupulously tracking the actual value of other executive's options -- that is, comparing the strike price to the market price for all of their competitors in the market for executive talent. Instead, it's more likely that they'd compare the quantity of options. That's why most option grants, at least to my knowledge, are nice round numbers -- one million options, rather than 1,112,343 options. But I'd be open to contradictory evidence. Beyond making fun of the word "norms," M&W do little to explain why backdating might have occured. Well, why did it occur? Give us your thoughts.
- Accounting rules did "punish" in-the-money options before the rules changed. If the option price was lower than the stock's market price, it had to be expensed; if not, it didn't. That's part of the reason no one issued options below that day's market price.
- I'm glad to know that, to M&W, accounting is so imperfect that "it’s a little like looking for your keys under the street light even though you lost them elsewhere. " I guess I can add "accounting nihilism" to the list.
In sum, I remain baffled as to why, if this is completely costless to everyone, executives felt the need to lie about the date of their options, rather than just issuing their options at a lower strike price. I have my theory. I'm still waiting for theirs.
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See here for a theory. Perhaps this led to backdating becoming a “market norm” as you say.
Posted by: Bill Sjostrom | Sep 3, 2006 7:52:03 PM
That seems to be a theory of the origin of backdating, not backdating coupled with improper computation of compensation. The latter is what was called for, I believe.
Posted by: Eric Morgenstern | Sep 4, 2006 2:23:07 PM
Thanks for cutting through the professorial economics jargon with a dose of common sense! Of course this was lying. "Law and economics" thinkers believe they're hardheaded realists, yet seem naive about the cultural issues at some companies that unquestionably fostered cheating.
Posted by: Wendy Fried | Oct 27, 2006 9:43:02 AM