The cynic within me has always believed that company board remuneration sub-committees are always working hard to find excuses to maximise the amount of shareholders’ cash awarded to the executives (and to themselves) in the form of salaries, bonuses, pensions, option-grants, and various parachute payments to protect the management teams’ wealth when things happen to wrong.
Lucian Bebchuk, Yaniv Grinstein and Urs Peyer in their research paper “Lucky CEOs and Lucky Directors” find that 15% of all at-the-money option grants to CEOs and 11% of those to directors between 1996-2005 just happened to coincide with the lowest stock price in a particular month. They note that “the gain to CEOs from lucky grants due to opportunistic timing exceeded, on average, 20% of the reported value of the grant, and added, on average, more than 10% to the CEO’s total reported compensation for the year.” In addition, they show that it is not only the executives that benefit from such opportunistic grants, but also the independent directors – ie. the very people who are in place to look after the interests of external shareholders. They go even further, showing that this is not related to the firms’ timing of routine options grants to a wider pool of managerial staff, but instead a something at only benefits the directors.
The research also looks into more detail at the causes of the grants and find evidence that I – admittedly a cynic – would argue is corporate corruption. Bebchuk, Grinstein and Peyer find that lucky option grants are positively correlated with CEO tenure and negatively correlated with the number of independent directors sitting on the board. In addition, they find that a majority of independent directors on the board only acts to reduce lucky grants to the CEO if they themselves do not receive lucky grants – implying to me that some independent directors are routinely taking advantage of their position to enrich themselves and the executives at the expense of shareholders, a clear dereliction of their duties to look after the interests of shareholders
They also note that lucky option grants are more likely to occur where the pay-offs from such grants were expected to be higher – ie. grants were timed not only to coincide with a low point in a particular month, but the month itself was likely to represent a trough in the share price. They also discover that if a CEO and/or directors have received lucky grants in the past, then they are more likely to receive them again at some point in the future, suggesting that poor corporate governance practices have become ingrained at some firms.
While the Wall Street Journal‘s exposé of option-backdating did impact upon lucky grants in the period shortly after publication (March 2006), I would argue that such grants are a symptom – not a cause – of poor corporate governance. The critical factor for me here is the evidence that when independent directors receive inappropriate compensation they are more likely to award the executives inappropriate compensation. I do not believe that this practice has necessarily ended simply because public and regulatory attention has been drawn to option backdating. My attention is now firmly focused on the “parachute” payments that executives can receive in various situations, particularly those that follow destruction of shareholder value.
- Goldfarb Branham LLP Investigating Enzo Biochem Shareholder Claims (eon.businesswire.com)
- New ‘say on pay’ law could temper CEO pay (marketwatch.com)
- UPDATE 1-SafeNet in $25 mln backdating accord (reuters.com)
- NYSE Corporate Governance Report (professorbainbridge.com)