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Backdating scandal claims McAfee, CNET execs

Kai Ryssdal Oct 11, 2006

KAI RYSSDAL: The official word is they resigned. And that might save some face for the now-former CEO’s and chairmen of McAfee and CNET. Let them walk away with comfortable golden parachutes. But really, they were pushed.

McAfee makes security and anti-virus software. CNET’s a big internet media firm. No admissions of intentional wrongdoing by anybody. Just apologies for mishandling stock options. If that sounds familiar, it is. CNET and McAfee are just the latest companies to stumble over their options grants.

Charles Elson teaches corporate governance at the University of Delaware. Professor Elson, remind us what this options scandal is.

CHARLES ELSON: Well, it’s this idea of backdating that’s really the problem. That is, of awarding an option where you’ve set the strike price — that is, the price at which the option is exercised at a date prior to the date it was actually awarded. Meaning you build in an instant profit to the option. And that’s the root of the controversy. It’s effectively betting on a horse race after the horse race is over.

RYSSDAL: Is there something about high-tech companies that make them more vulnerable to this sort of thing? It has been so far largely tech companies that have gotten in trouble. Today’s news only confirms that.

ELSON: Well, I think that tech companies, more than a lot of companies, made extensive use of options back in the ’90s. Number one, obviously, the more you make use of options, the more likely you are that something could possibly go wrong. Secondly, I think in Silicon Valley, because these were young, entrepreneurial companies, I think a lot of people felt less than diligent in their adherence to modern corporate governance standard and other forms of corporate formalities.

RYSSDAL: You know, they might be cheap for the company but are these options being granted to these executives in numbers large enough to dilute shareholder value?

ELSON: Oh, absolutely. And that’s been a great criticism of them, particularly in Silicon Valley companies where you have such a huge number of options granted that you’ve effectively diluted the dickens out of everybody else.

RYSSDAL: The theory behind giving executives a stake in the company, of course, is that they will then be motivated to do better things for the company and make everybody’s shares worth more. But if you give them options, don’t you sort of pervert that whole thing and turn capitalism, really, sort of sideways?

ELSON: Well, the option was intended as a tool to align the executive’s interest with the other shareholders. The problem with an option is it’s an expectancy, and if you’ve set the strike price inappropriately, as was obviously done in the backdating, they can work very differently and not really create the alignment you’re looking for. Additionally, there’s the concern that once you exercise the option and sell the stock you lose the incentive. The option leads to short-termism on the part of executives and the potential for manipulation of the stock price immediately prior to exercise.

RYSSDAL: How concerned are you as an observer that the companies that are being mentioned now in some of these cases — McAfee and C-Net today, and some of the other big ones like Apple — I mean, these are name companies that are doing this sort of questionable thing?

ELSON: It’s a real problem. And, obviously, we want to see in the end what exactly happened in these companies. But from an investor standpoint it is disturbing that such quality names would be caught up in this mess. But, again, it depends on what the backdating was all about. Was it merely accidental? Was it sloppy recordkeeping? Or was it something more intentional that was designed to profit those involved?

RYSSDAL: You don’t really believe any of this was an accident and somebody wrote the wrong date?

ELSON: Uh, you know, it could very well. You know, in a company with less-than-steller recordkeeping sometimes that happens. But, again, it seemed that there was a great deal of options granted on the lowest possible dates. And that was very, very odd. And can only be explained either to extraordinary luck or some kind of bad behavior.

RYSSDAL: What’s left to come on this stock-option story? There will be, I’m sure, more companies that we’re all very familiar with.

ELSON: A virtual warehouse of shoes to drop, Kai . . . unfortunately. The interesting question will be what the regulators will do with this. Obviously, a company investigation is one thing, and an SEC investigation is quite something else.

RYSSDAL: Charles Elson runs the Weinberg Center for Corporate Governance at the University of Delaware. Professor Elson, thanks for your time.

ELSON: Great. Thank you.

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