5 ........................Chennai Chapter Report 6 ... - National HRD Network

Employee Stock Options (ESOPs)
– Dr. T.H.Chowdary
Many new economy companies in the
IT, software and telecommunications
have been issuing employee stock options.
They proudly pronounce them as part of their
policy to create value for stake- holders; that
is, equity share holders and employees. It
has become fashionable to issue stock
options. That these are a deception, a fraud
on the equity share holders has been
established by no less a person than the
Nobel Laureate, Joseph Stiglitz in his book,
"The Roaring Nineties". To state briefly, he
holds that these are expenses which the
company incurs but are not explicitly shown
in the Profit and Loss Account or Balance
Sheet of the companies. These depress the
profits as well as reduce the market value
of the equity shares. The share holders
cannot make out this well-concealed effect
from a reading of the P&L account and
Balance Sheet. The following are his
observations.
2. Stock options, the right to buy
company's stock at below market prices -
and then pretending that nothing of value
has changed hands was extensively
resorted to by Silicon Valley companies
since the 1990s…..Options were of course
a terrific recruiting tool for small profitless
start -ups that could never have come up
with their equivalent cash. One of the
corporate Manthras of the day was, through
stock options, "bring manager and share
holder interest into alignment." Since no
actual stock got issued until they were
"exercised (which might be several years
down the road), they did not have to be
acknowledged as an expense - a some thing
the firm has spent, or a liability it has incurred
in order to do business that year. Thus, a
company could please employees and
bottom -line conscious investors at the same
time".
"By 2001, options accounted for an
estimated 80 percent of the compensation
of American corporate managers, and the
impact on the Balance Sheet wasn't exactly
trivial, either. IF Microsoft had been required
to acknowledge the value of the options it
doled out that year, the effect would have
been to reduce the company's 2001 profits
(officially, $7.3 billion) by a third. The same
play had enabled both Starbucks and Cisco,
among other companies, to boost profits by
20 percent or more. Intel's profits would have
been cut to a fifth, from $1.3 billion to $254
million, and Yahoo!'s losses would have
increased tenfold, from $93 million to $ 983
million.
Using this device of stock options some of
the notoriously failed companies like Enron,
World Com, Adelphia , the most flagrant and
well publicized of many companies, went
more and more into new ways of maximizing
executives' gains at unwary investors
expense.
The Financial Accounting Standards Board
(FASB) of the USA, an independent body
responsible for formulating accounting
standards came out with draft rules intended
to make companies put a reasonable value
on options and list them as expense but the
FASB was destructively criticized by the
Chiefs of the then Chiefs of companies of
the likes of Enron, WorldCom and Home
Depot, characterizing the FASB's rules as a
terrible blow to the free enterprise system"
which would make it impossible to start up
new businesses . In the event the FASB
adopted a watered down rule that merely
required companies to report all stock options
in foot notes to their financial statements.
Arthur Levitt, Chairman of the Securities
Exchange Board (SEB) later called it the
"biggest mistake" of his tenure at the SEB .
3. Executive pay became a topic of
growing controversy in the later part of the
decade, as stock options enabled the likes
of John Chambers of Cisco, Dennis
Kozlowski of Tyco, Stanford I.Weill of
Citicorp, and David Komansky of Merrill
Lynch to pocket millions of dollars. But while
there was plenty of outrage over the
amounts of money involved - the popular
view was simply that these executives were
being paid too much-other aspects of the
question got slighted.
4. Stock options depressed the share
value in the market in the following way.
When executives (or other employees)
receive stock options, a company is
committing itself to issue new stock, thereby
diluting the value of the existing stock.
Assume a case in which there are already 1
million shares outstanding, each worth $30;
that would make the company's value ( or
"market capitalization") $30 million. If its
executives get, say, an additional 1 million
shares free, then the old shareholders will
have to share the company's wealth-and
future profits-with these "new" shareholders,
and the value of each share will fall to $15.
Thus, the shareholders effectively pay the
executives $15 million - not straight out of
their own pockets, but through the
diminution in their share value.
5. The Nobel Laureate Stiglitz says , "we
might speak of stock options as corporate
theft -executives stealing money from their
very share holders". He further wrote that it
is absolutely wrong to hold that the
performance of the management has
anything to do with the share price in the
market. He observes, "in a stock market
boom most of the increase in the value of
stock has nothing to do with the efforts of
the management" .
6. He further observes trenchantly, the
incentive pay that Compensations
Committees of some companies
characterize the stock options is an
euphemism for "big pay". Cisco's John
Chambers voluntarily cut his annual pay to
$1 but still received a 6 million stock option
in fiscal 2001 even as his company lost $1
billion and its stock price fell 70 percent. But
the practice is so widespread that on
average, there appears little relationship
between compensation and reward.
7. During the 1990s senior executive
compensation rose by 442 percent in eight
years, from an average of $2 million to $
10.6 million. Compensation of American
executives was completely out of line
relative to the salaries of middle
management, relative to the salaries of
workers, relative to anything imaginable.
While senior executive compensation rose
36 percent in 1998 over 1997, the wages of
the average blue-collar worker rose just 2.7
percent in the same period. And the pattern
was repeated over and over again. Even in
2001, a disaster year of profits and stock
prices, executive CEO pay increased twice
as fast as the pay of the average worker.
8. The Nobel Laureate goes on to compare
the compensations in some countries as
follows: In Japan, executive pay is typically
10 times that of the average worker; in Great
Britain executive pay is 25 times that of the
average worker; by 2000 in America, CEOs
were getting more than 500 times the wages
of the average employee, up from 85 times
at the beginning of the decade and 42 times
two decades earlier
9. He concludes most educatively; " new
forms of deception have been developed.
In the go-go environment of the 1990s while
market values soared, human values
eroded, and the playing field became terribly
unlevel once again, contributing to the
bubble that burst soon after the beginning
Contd. on Page 32
Dr. T Hanuman Choudary is Fellow: Tata Consultancy Services & Satyam Computer Services and Former Chairman & Managing Director,
Videsh Sanchar Nigam Ltd. E-Mail: hanuman.chowdary@tcs.com & thc@satyam.com
| HRD News Letter | April 2008, Vol.24, Issue:1 33