How many misunderstandings can the Wall Street Journal's reporters pack into one article on backdating? We're still counting.
Our earlier post focused on how the Journal's report was misleading about the rationales for awarding stock options and the how backdating affects those rationales. But the reporters also seem to misunderstand the process of how stock options are awarded.
The reporters note that the chief financial officer of Broadcom urged that the options awards to executives be dated on December 24th. They then add:
They were, and that was fortunate for recipients. Broadcom's share price rose 23% between the two dates. The pretense that the options had been granted on the earlier date made them extra valuable.
That sure is snide and sounds clever. But it rests on a very fundamental misunderstanding of how options are awarded. It's not very likely the executives of Broadcom was destined to get a set amount of options, and so pricing them on an earlier date inflated their pay. It's far more likely that the executives at Broadcom were going to receive total compensation packages worth a certain amount, and that dating the option grants earlier just allowed the company to issue fewer options.
The explicit nature of the chief financial officer's email makes it very clear that the intent was not to somehow conceal how much the executives were getting paid. Anyone with a pencil, a calculator and a piece of paper could figure out what the options granted on January 4th, but priced at December 24th's share price, were worth. This, in fact, is one of the advantages of backdating—pegging the grant to a date in the past on which the price is known, makes it easier to know how much the options are worth. Pegging them to a moving number—such as the share price on whatever day the options are actually awarded—makes the calculation more difficult.
What's more, a phenomenon that economists call the "endowment effect" seems to affect executive decision making here. Executives prefer options that seem to be already worth something on the date granted, even if those options will take years to vest and may actually be worthless (if the stock goes down) by then. In short, Broadcom's chief financial officer might have known he could cleverly shortchange the executives by granting them "in the money" backdated options since they would consider these worth more than even straight cash. It certainly would allow the company to preserve more of its cash.
There's another point worth making. Presumably the actions of the executives helped cause whatever it was that pushed Broadcom's stock price up 23% in 11 days. Is it totally unfair that they might expect to be able to benefit from this explosion in shareholder value? Or do we want to create incentives for executives to hold-off on releasing positive news about their companies until after they receive their options?
[Editors Note: Okay. We might be getting a little "flood-the-zone"-ish when it comes to Friday's big, front-page Wall Street Journal article on backdating. This is our third post on it. We'd like to say that we've covered it all but we haven't. More in a few moments.]
Probes of Backdating Move To A Faster Track
[$$] [Wall Street Journal]