One of the reasons spring-loading executive stock options seems so possibly scandalous is the same reason backdating did—it has been carried out in an underhanded way.
When these unusual options grants were revealed to shareholders, journalists, and regulators, immediately everyone wanted to know why executives were being so sneaky if they didn’t have anything to hide.
In short: why engage in accounting chicanery unless you are doing something you shouldn’t be doing?
In both backdating and spring-loading, however, the assumption that the stock options were structured to cheat shareholders seems wrong. What was really going on was probably just companies trying to avoid taking tax hits on options grants.
With backdating, the driving force largely appears to have been an accounting dodge that sometimes saved companies money on taxes. Under now defunct accounting rules, when companies granted in the money options, they were required to expense them immediately. Probably more importantly, ‘in the money’ options had more than accounting costs. They were actually costly because they were treated as non-performance based compensation for tax purposes, which meant companies couldn’t deduct expenses beyond $1 million. It was far cheaper to maintain the deductibility by backdating the stock option to look like a tax advantaged ‘at the money’ option.
Something very similar seems to be going on with spring-loading. Here the taxes being avoided are punitive taxes on “golden parachute payments.” These taxes were put in place to curb what some lawmakers claimed were “abusive” large payments when a company was acquired. And they are seriously punitive—the individual receiving them gets hit with an excise tax and the company is denied a tax deduction for the payment. Nevertheless, they never really worked as planned—companies wound up actually increasing the payments by providing tax gross-ups to executives receiving the golden parachutes.
Ironically, shareholders were the real losers in the golden parachute wars. The lawmakers claimed to be protecting them but the companies wound up paying for both the parachute and the gross up. The only real winners were the politicians who got a bit more tax revenue to spend.
This added cost of gross-up can be avoided, however, if the executive is paid in ‘at the money’ options. I structured correctly, these aren’t subject to the golden parachute tax. This means that granting spring-loaded options may actually be saving shareholders money—if the alternative were a taxable golden parachute.
“When I read this story this am, my first reaction was: Huh. Firms have found a way to end run non-deductibility of golden parachute payments and the 20% excise tax imposed on their recipients,” UCLA law professor Stephen Bainbridge writes. “Assuming the options are structured so as to avoid being treated as ‘parachute payments’ as defined by the IRS, what we’re dealing with here is a tax dodge, not insider trading or securities fraud”
Once again, it looks like this isn’t really a fight between shareholders and executives at all. It is a really a struggle where shareholders and executives are on the same side, battling a voracious tax system.