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Reward CEOs with ‘hands-off options’

Marketplace Staff Jul 27, 2007

Reward CEOs with ‘hands-off options’

Marketplace Staff Jul 27, 2007


Kai Ryssdal: Former Qwest CEO Joseph Nacchio had his day in court today. It cost him $71 million in fines and restitution and six years in jail. Nacchio was convicted of insider trading back in April — part of a $3 billion accounting scandal at the telecommunications company.

Corporate America’s latest no-no is something called stock-option backdating. The first criminal trial on that count is set to go to a jury in San Francisco. Former Brocade Communications CEO Greg Reyes is on trial for fudging the books over the timing of options grants.

Commentator Jesse Fried says there’s a better way to give executives incentive pay.

Jesse Fried: Many CEOs get rich off stock options, even when investors fare poorly. Boards could easily solve this problem. But executives like things the way they are. And boards are too timid to insist options be structured properly.

Here’s one big defect in option pay: CEOs get far too much control over when options are granted and when they’re cashed out.

Thanks to executives’ influence over option grant dates, we’ve had widespread backdating — the falsifying of grant dates to fatten the option kitty. And spring-loading — CEOs getting options right before good news is announced, giving them a built-in gain.

At the back end, boards let CEOs choose when to cash out their options. So they can use inside information to exercise their options and dump the stock ahead of bad news. This lets them make billions of dollars a year in insider-trading profits, while shareholders are left holding the bag.

It’s not hard to eliminate CEOs’ influence over when options are given and unwound.

But no company has done so until now.

This spring, just as the swell of news about backdating was subsiding, a Colorado-based company, Level 3 Communications, announced a plan that I call “Hands-off options.” (It’s the brainchild of the Frederic Cook consulting firm.)

This investor-friendly plan is really quite simple.

First, options are issued in 12, equal, monthly installments. The schedule is announced far in advance. This makes option grant-date manipulation —like backdating and springloading — impossible.

Second, each option installment is cashed out automatically at a fixed date several years later. That means Level 3 managers can’t make extra profits at the back end by using inside information to time their option exercises and stock sales.

At long last, one board is finally prying executives’ hands off the options cookie jar.

Will other companies rush to follow Level 3’s example? Don’t hold your breath. Boards eagerly embrace new pay practices that provide sweet deals for CEOs. But they are very reluctant to tie pay more tightly to performance.

Ryssdal: Jesse Fried is a professor of law at the University of California-Berkeley. His book about executive compensation is called “Pay Without Performance.”

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