What's a Little Payoff Between Friends

My esteemed colleague Garance Franke-Ruta has some new exclusive goods on George Allen and his stock options:

On October 20, 2000 -- just 18 days before former Virginia Governor George Allen was elected to the U.S. Senate -- Xybernaut, a Virginia-based technology company, on whose board Allen served, held an early annual shareholder meeting and awarded Allen a tidy bonus of 50,000 stock options. Allen was granted the stock as part of his re-election to the board at a time when polls showed him to be the favorite in the impending senate election against Democrat Chuck Robb, and when it was clear that he would have to resign his board seat if and when he became a senator. Senate rules forbid members from serving on corporate boards.

The issuance of these options, whose existence is confirmed by the Form Five filing with the Securities and Exchange Commission that The American Prospect is posting in conjunction with this piece, raises questions about why Xybernaut (which filed for bankruptcy in 2005) granted them to Allen so soon before his election to the Senate, and what, if anything, the company expected in return for them. Stock options, a controversial form of director compensation, "are designed to encourage future risk taking and align the interest of the director with the interests of the shareholder," says attorney Beth Young, a corporate governance expert now lecturing at Harvard Law School. Re-electing a director who might have to resign within weeks "is a little unusual," she says, and granting him additional options prior to his anticipated departure at an early annual meeting is "very unusual."

It looks, in other words, like Xybernaut (see more on them) found themselves a clever way to de facto keep paying Allen even while he took office as a US Senator.

Comments

I don't know why Garance has to lie in this article.

She writes that he was granted additional options at an "early annual meeting" (something said to be "very unusual"). Even a 2 minute glance at the facts shows this is not true. The meeting was earlier than the prior year's annual meeting (December 28, 1999), but it was later than the annual meetings in the two years prior to that (August 27, 1997 and September 24, 1998) as well as the two meeting thereafter (June 18, 2001 and June 18, 2002).

It would have been a good article if Garance hadn't seen fit to lie in an attempt to twist the knife a bit more.

(I'd also take issue with whether it is unusual for reelect a director who is running for office and thus might have to resign - but that's a judgement call, and not as clear cut as the lie discussed above.)

Posted by Al | November 1, 2006 1:30 PM

How far in advance are annual meetings usually scheduled? The article says the shareholders were notified in September about the annual meeting. It could can an "unusual early meeting" if the meeting was resecheduled from a later date because of Allen's upcoming election. It could be that, or she could just be mistaken.

Aside from that, the rest of the article has some interesting questions. It always raises suspicions when people can't get their stories straight or keep changing them.

Posted by Rambuncle | November 1, 2006 3:13 PM

"It looks, in other words, like Xybernaut (see more on them) found themselves a clever way to de facto keep paying Allen even while he took office as a US Senator."

Sort of like that Vice-President guy who used to run that major defense contractor; what was his name? Is he still a big deal or anything...?

Posted by MFA | November 1, 2006 3:49 PM

How far in advance are annual meetings usually scheduled?

Proxy statements are usually sent to shareholders about a month in advance of the meeting.

In this case, the proxy statement was mailed 9/27 for a 10/20 meeting. That doesn't differ materially from the prior year (the proxy was mailed November 30 for a December 28 meeting) or the following year (the proxy was mailed May 25 for a June 18 meeting).

However, I suspect Garance wasn't talking about when the proxy was mailed, but rather the date during the year when the meeting was scheduled. As I noted above, an October meeting is actually relatively late for Xybernaut, not early as Garance would have you believe.

Posted by Al | November 1, 2006 4:56 PM

She wasn't lying, she was just a bit afield. She's not a corporate governance expert.

She's obviously incorrect that stock options are "a controversial form of director compensation." Nine times out of ten they aren't, unless they are backdated or given excessively without any expectation of performance.

She also didn't say it was "very unusual." That was attorney Beth Young, a corporate governance expert now lecturing at Harvard Law School.

Posted by Bob | November 1, 2006 5:59 PM

Leaving aside fairly pointless questions about the timing of the Board meeting, my question is: Were any other directors granted similar quantities/types of options? If not, why was Allen singled out for this? Or do we even need to ask......

Posted by Uncle Jeffy | November 1, 2006 6:13 PM

Uncle Jeffy:

Xybernaut had a classified board, so only 4 directors were elected at the October 20, 2000 meeting: Allen, Edward Newman (the CEO), Steven Newman (an Executive VP), and James J. Ralabate.

Xybernaut's policy for compensation of directors to pay in options (in lieu of cash directors fees). Their proxy statement said that directors who were elected would get 50,000 options, and directors who were not up for election (because their class on the baord was not up for election) would get 10,000 options. In accordance with this policy, the other directors elected at the meeting beside Sen. Allen (Edward Newman, Steven Newman, and James Ralabate) were all ALSO paid 50,000 options on October 20, 2000, and each of the other continuing directors were all paid 10,000 options on October 20, 2000. You can see that in the "Options Granted" table on page 9 of the following year's proxy.

There was nothing unusual about the grant of 50,000 options to Allen. It was in accordance with Xybernaut's director compensation policy, and was exactly the same as the compensation paid to the other directors elected at the meeting.

More evidence that Garance's little hit piece is a fraud.

Posted by Al | November 1, 2006 6:49 PM

She also didn't say it was "very unusual." That was attorney Beth Young, a corporate governance expert now lecturing at Harvard Law School.

No, Garance said that he was granted the options at an "early annual meeting" - a practice that Ms. Young said was "very unusual". As I pointed out, it is flat out false that the meeting was early.

Posted by Al | November 1, 2006 6:51 PM

One odd omission from the article was any mention of the strike price of the options in question. If the price of the stock was and remained below the strike price then the options were worthless. If the price of the stock rose above the strik price AND HE EXCERCISED HIS OPTIONS, then his windfall would have been substantial and noteworthy. She notes the 50,000 options as if this is, in itself, has value. That she makes no mention of him ever actually realizing any profit is very strange as it should be the focal point of the article.

Posted by Robert | November 2, 2006 6:12 AM

She's obviously incorrect that stock options are "a controversial form of director compensation."

A version of this post is being held for too many links, but the short version is this:
The fact that stock options became an issue in the last presidential election would be enough to make them controversial. I don't mean to make any claims about the merits of the case, just saying that they are controversial. Note also, contra Robert, that the expected value of a stock option isn't zero even if the price is below the strike price. Of course options have value; if you could trade them on the open market you'd never give them away.

Posted by Matt Weiner | November 2, 2006 9:20 AM

Matt Weiner is correct that options have value even while the market price of the underlying stock is below the exercise price of the option. As with most options, I'd expect that Allen's options were issued with a strike price equal to the market price of the underlying stock on the date of grant. At the time these exercises were granted, companies were not required to include the value of the options as an expense in their financials. Recently, though, under FAS 123R, companies would be required to expense the options.

Nonetheless, Weiner is wrong to say that fact that stock options became an issue in the last presidential election makes them controversial. That's like saying that because military service became an issue in the last election it is controversial. Issuance of options as compensation is completely banal; like many banal topics, though, it can be made into a "controversy" through fraudulent charges like the ones made in Garance's article.

Posted by Al | November 2, 2006 9:52 AM

Yeah, well, the moderated version of the post points out that 13.8% of stock options are backdated or otherwise manipulated, that (as stated in the link) there's a big controversy about how to value stock options, and that many business ethicists (and Nobel Prize-winning Joe Stiglitz, among others) are worried about the perverse incentives that stock options give executives to manipulate earnings reports. Also this:

That's like saying that because military service became an issue in the last election it is controversial

is silly; the difference is between a couple of people's military service and a general argument about how to regulate stock options. If someone had been making a general argument that we needed to reform the way military service was done, it would've been accurate to say that military service is controversial.

Posted by Matt Weiner | November 2, 2006 10:39 AM

I should just say that I teach an accounting ethics class and it's impossible to read up on the subject without encountering concerns about the ethical impact of stock options.

Posted by Matt Weiner | November 2, 2006 10:46 AM

To Matt Weiner's point about stock options having secondary value: That is true if and only if those options are available for trade. Typically option awards cannot be traded on the secondary market. They can only be excercised or abandoned by the awardee. In any case, it doesn't change my underlying objection to Garance's article. She doesn't address the value of the options (excercised or otherwise) and that is the key to any potentially ill gotten gain on Allen's part.

Posted by Robert | November 2, 2006 7:17 PM