In a move that clearly turns up the heat on executive compensation, the Amalgamated Bank has filed lawsuits charging that executives at Cisco Systems and Tyson Foods illegally granted themselves stock options before they announced good news.
Amalgamated Bank is the trustee for LongView MidCap 400 Index Fund and LongView Collective Investment Fund, which have investments in the two stocks. The activist investors allege that Cisco delayed issuing positive news to keep its stock price stable until after completing an options grant to "several top executives, according to www.thedeal.com.
"The options grants were clearly orchestrated by insiders to coincide with, or in anticipation of, the happening of a material corporate event that was known to insiders making or accepting the grants, but not to the shareholding public," the complaint reportedly said.
“This is the next new wave of litigation,” asserts Patrick McGurn, of Institutional Shareholder Services. “It’s the opening salvo in a large offensive.”
"A Long List Of Companies
Taxin
In fact, Greg Taxin, CEO of Glass Lewis, insists Cisco and Tyson are not isolated incidents. He says the practice of awarding options to executives shortly before their company announces good news is surprisingly prevalent. ”We have a long list of companies that have done this,” he says.
According to Taxin, Glass Lewis studied 16,500 grants made to executives in 2003 and 2004. One month later, the underlying stock was 25 percent higher for 1,422 of the grants, or 8.6 percent of the total.
Looking out 60 days, the underlying stock surged more than 25 percent for 2,670 grants, or more than 16 percent of the total.
Even after one week, the underlying stock of 289 grants climbed 25 percent.
“I do believe people are surprised to hear this,” Taxin concedes.
Timing Opportunism
Now, one of the reasons that executives benefit so quickly from good news is because they typically receive options whose strike price is equal to the stock price at the time of grant. So, if the options are awarded when the stock sags a bit, the executive is almost guaranteed to make money right from the start.
In fact, there are a number of academic studies that have been conducted in the past few years that show that option grants to CEOs tend to occur on days when stock prices had sagged somewhat. These were essentially the conclusions of research from Professor David Yermack in a 1997 Journal of Finance article, and professors Keith Chauvin and Catherine Shenoy in a 2001 Journal of Corporate Finance article.
Donal Byard and Ying Li, assistant professors in the Stan Ross Department of Accountancy in the Zicklin School of Business at Baruch College, part of the City University of New York, found in a recent study that the extent of CEOs' timing opportunism was greater in firms where CEOs receive a higher proportion of their compensation from stock options.
They also concluded that there was more timing opportunism in companies with poor corporate governance quality. They measured governance quality as the proportion of inside directors on the compensation committee and the board, according to a recently published report.
“Most importantly, we found that directors' option compensation affected the extent of a CEO's timing opportunism after controlling for corporate governance quality,” they wrote back in December in a special column for ISS. “That is to say, directors' own option grants affected the extent to which they curtailed the CEO's opportunism. For a given level of option grants to a CEO, there was more timing opportunism when directors received a higher proportion of stock options in their compensation. This finding supports our hypothesis that directors are less likely to limit the CEO's timing opportunism when they themselves stand to benefit more from this opportunism.”
Attractive Targets
So, if this practice is so widespread, why did Amalgamated single out Tyson and Cisco?
Eisenhofer
Jay Eisenhofer of Wilmington, Del.-based Grant & Eisenhofer, who also serves as Amalgamated's lawyer, insists it probably had to do with their history of questionable corporate governance practices.
“It makes them attractive targets,” he says. “Investors such as Amalgamated like to go after companies that are bad actors rather than those that engage in one incident of bad conduct.”
He especially singled out Tyson for engaging in related-party transactions and enriching the founding Tyson family.
The Amalgamated suit, in fact, alleges that between 2001 and 2003 the Tyson family was paid $51 million in transactions with the company "that were unfair to the corporation and served to enrich corporate insiders to the detriment of Tyson,” according to www.thedeal.com.
Amalgamated also reportedly referred to "fortuitously timed stock options grants" to Tyson family members and executives, which it asserts costs shareholders at least $2.8 billion. In fact, the suit alleges that in least four cases since 1999, Tyson's compensation committee awarded stock options just a few days before the company issued news that drove up the price of Tyson's stock, according to the report.
A good example came a day before Tyson announced it would scrap its deal to buy IBP. The compensation committee reportedly awarded 350,000 options just one day before Tyson made the announcement, which resulted in Tyson’s stock surging 17 percent.
Eisenhofer also criticized Cisco for its compensation practices and timing of option grants. In fact, back in September 2003, Cisco caused a bit of controversy when it doled out 141 million stock options to employees a few hours before chairman John Chambers delivered a strong report about company orders, which sent Cisco's stock up 3.3 percent, according to The Wall Street Journal, at the time.
Indeed, in 2003 four of Cisco’s top three executives alone netted $66 million from exercising stock options.
Despite these events, Glass, Lewis’ Taxin stresses that you shouldn’t read into his firm’s study and think that the companies whose stocks surged shortly after they issued options engaged in illegal or sleazy acts. He believes that in many cases—“maybe most”—it’s a coincidence or happenstance.
But, told that 8 percent of grants rising 25 percent after a month seems like a lot, he says, “I agree.”
No comments yet