Another options grant story is trumpeted on the front page of the The Wall Street Journal. Those of us who remember how the backdating scandal started out with a bang and ended with a whimper should be asking whether this is another media-manufactured nonscandal.
Before we get to our doubts about the latest options grant scandal, let’s run through the mechanics.
- Once again, the Wall Street Journal has picked up the trail of a largely unknown options grant practice that was first uncovered in an academic paper.
- This time around, the practice involves awarding stock options to top executives during negotiations for acquisitions.
- These options grants mean that the executives get bigger paydays when the merger is announced and the stock shoots up.
- In those deals where CEOs got the well-timed, unscheduled options grant, shareholders got a lower takeover premium than shareholders in companies that didn’t give these ‘spring loaded’ grants.
The paper’s authors, Eliezer Fich, Jie Cai, and Anh L. Tra, and WSJ reporter Mark Maremont, one of the reporters who won the Pulitzer Prize for reporting on backdating, clearly think they’ve uncovered a major scandal. While Maremont notes that the practice is probably legal, they clearly imply that shareholders are getting cheated while executives are enriched.
“We estimate that in deals involving these firms, shareholders lose about 307 million dollars,” the academics write. “To put this result in perspective, the average target loses 54 dollars for every dollar their CEO gets from unscheduled options granted during private merger negotiations.”
Is this what’s really happening? We’re not so sure. The evidence could actually cut the other way. The crucial finding that the academics think is truly damning is that shareholders in these deals received lower takeover premiums than average. If that is because executives didn’t negotiate good deals because they were getting the spring loaded options grants–as the academics believe–then clearly shareholders are being hurt.
But that’s not necessarily the case. It could be that the lower takeover premium reflected the maximum price the buyer was willing to pay but that price was too low to entice the target’s executives to sell. In that case, the options grants to executives may have prompted a sale where none would have otherwise occurred.
It’s possible that if not for the spring loading, shareholders would not have received any takeover premium at all because the deal would never have been closed. In other words, spring loading may be allowing the shareholders of the targets to get premiums that would have otherwise been unavailable. This is at least as consistent with the correlation of lower premiums and spring loading as the scandalizing conclusion drawn by the academics.
The core problem with the paper and the WSJ piece is that both seem to assume that the acquisitions would have gone forward without the spring loaded options. It isn’t obvious why we should accept that assumption.
Law professor Larry Ribstein points out another defect in the scandalizing of spring-loading. Diversified shareholders don’t necessarily have an interest one way or the other in takeover premiums. They may well own shares in both the target and the acquirer, which makes the takeover a wash from their perspective. But they do have an interest in wealth maximizing, efficient deals being completed.
Executives at many companies, however, have a good deal of their wealth tied up in the stock of their employer. This means that executives at takeover targets may hold out for premiums that are too high, turning away deals that would benefit diversified shareholders. Granting spring loaded options may actually be realigning the interests of executives with diversified shareholders.
This doesn’t completely exonerate the executives involved, of course. But hopefully we’ve all learned out lesson from the panic over backdating and can approach this latest options grant muckraking with a bit more sobriety this time around.
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