The boardroom titans of Silicon Valley and Wall Street have met their match in a Norwegian-born finance lecturer from a hitherto obscure business school in America’s midwestern cornbelt.
Erik Lie, a professor at the Henry B Tippie College of Business in Iowa City, is credited with triggering a scandal over share options that has so far snared more than 60 companies — including Apple, Microsoft and the world’s largest do-it-yourself retailer, Home Depot.
The companies are facing scrutiny — in some cases, a formal regulatory investigation — over the way they have priced share options for their executives. They are accused of using unorthodox tactics to ensure the maximum possible financial gain for boardroom bosses.
Lie, a 37-year-old academic who has enlivened his personal website with the Viking cartoon Hagar the Horrible, published a paper last year in which he examined the curious way in which options were priced during the technology boom of the late 1990s.
His thesis is straightforward. Options, which allow executives to buy shares at a pre-determined price at some point in the future, are supposed to be a reward for making the stock go up. Lie believes that in many cases options were ”backdated” — pitched retrospectively at a record low in the share price. Some firms may have been ”spring-loading” options by setting them just before a positive announcement bound to boost the price.
Others chose their stock price nadir, just after a disaster, on the basis that the only way is up.
He sent his work to the Securities and Exchange Commission (SEC), which described it as ”interesting”. Since then, the SEC has interviewed him and, with the United States Department of Justice, has opened a wide-ranging inquiry into the way options are handled.
Lie believes the practice was widespread until corporate governance legislation in 2002 required option grants to be announced within two days.
Although he has been feted by the American media, he insists he is not a whistle-blower: ”A whistle-blower is someone on the inside of a company who reveals wrongdoing. I see myself as a researcher — I have looked at the data and identified trends. That is what researchers do.
”This is my 15 minutes of fame. I have no doubt that my 15 minutes will pass.” Among those caught up in the furore is Steve Jobs, the billionaire founder of Apple. The computer mogul takes a symbolic salary of $1, but he has built his wealth on shares.
On January 19 2000, Apple announced that Jobs had been granted 10-million share options with a strike price of $87,19, a two-month low that Apple’s shares had touched a week earlier. But by the time of the announcement, the stock had jumped to $106,56, creating an instant notional profit for him of $193-million.
In the event, Jobs made no direct gain because he held on to the options and the share price fell. He won permission from his board in 2003 to swap the options for restricted shares.
Other corporate bosses, particularly at high-tech enterprises, do appear to have profited from similar situations.
An analysis by the Wall Street Journal of Internet job search company Monster.com found it had made seven grants of options between 1997 and 2001 to its CEO, James Treacy. One grant was at a 12-month low in the stock price and three others were at quarterly low points. The possibility of this happening by chance, if the options were set on random dates, is one in nine million.
John Coffee, a corporate governance expert at New York’s Columbia Law School, said: ”In a sense, it’s déja vu. Cases like Enron and WorldCom were all about inflating income in order that managers could inflate their options. This second scandal comes from the very sudden transition from paying in cash to paying in shares during the late 1990s.”
Coffee said that, at the beginning of the 1990s, American executives received 90% of their pay in cash. By the end of the decade, they received two-thirds of it in shares. ”It was a transition that happened so fast, it wasn’t accompanied by all the safeguards corporate governance needs. If you can get rich by exploiting some of the little niches, you’ll get people doing it.”
The legality of all this is complicated. There is nothing unlawful about backdating options as long as companies account for them adequately as already being in profit — which many of them have failed to do.
So-called ”springloading” can be a breach of insider trading rules and has been condemned by corporate governance campaigners as grossly unfair.
In the most serious case of options misbehaviour, a California firm, Mercury Technology, last week slashed $524-million off its net income in a restatement of all its accounts from 1992 to 2004 after an independent investigation of its boardroom rewards. Three directors have received notification from the SEC of possible charges.
Stephen Hall, a New York consultant who advises companies on executive pay, believes the strategies were motivated by a desire to retain staff: ”Companies were always trying to figure out how they could put glue on people. But no doubt a greed element enters into it.”
He adds: ”It’s ugly. It’s the biggest black eye executive remuneration will receive in 2006.” — Â