Thursday, April 27, 2006
I wish I could summarize every session but until I pick others’ brains at tonight’s GEO Awards ceremony I’ll have to limit my comments to the sessions I attended.
Beyond the Great Wall – Case Studies
John Bagdonas and Warren Miles (Computershare) plus Cheryl Spielman (Ernst & Young) discussed the complexities of equity compensation in China. If you thought learning the language was the most challenging aspect of venturing to this nation, you haven’t designed and implemented an equity compensation plan there. For many years employers have faced uncertainties due to the lack of regulation there, and recent introduction of some rules hasn’t made things much better.
Ironically, PRC - with its communist worker-oriented philosophy - somehow overlooked in its recent legislation the need for accommodating all-employee share plans. Recognizing the critical role that equity-based compensation can play in encouraging growth and profitability of enterprises, the government is (finally) addressing the topic in its securities and tax laws to help companies understand the rules but their clarification is thus far limited to executives and “key” employees. Of course, many global equity professionals would argue that all employees are key employees, thus the basis for all-employee equity plans. There is still the challenge that PRC prohibits Chinese nationals from owning shares of foreign companies but one cannot find a law stating such restriction, which is somewhat funny until you have to deal with it.
Key points learned: What I also found humorous is that the PRC treats the Hong Kong Stock Exchange as a foreign exchange. Go figure.
Key terms you’ll need to know to converse on this topic: CSRC, Circular 35, SOE, Red Chips, SASAC.
The Impact of Section 409A on Global Equity Plans
This panel - Bill Dunn (PriceWaterhouseCoopers) and Frederic Singerman and David Weiner of Seyfarth Shaw - discussed how the American Jobs Creation Act of 2004 and resulting US tax code Section 409A (the experts pronounce this “Four Oh Nine Cap A) continue to create jobs for lawyers, tax specialists, and consultants. Companies and their advisors are grappling with the complexity of a law intended to stem the abuse in nonqualified deferred compensation arrangements but resulted in unintended effects on equity compensation programs here and around the world. As difficult as this new set of rules has been for companies based and operating in the US, the implications for global firms are truly overwhelming. Mr. Dunn gave the example that a US citizen working in France and subject to taxation in the US who receives a non-discounted stock option there may receive what, under 409A, is a discounted option and have that option taxed at vesting (rather than at the time of exercise) as a result of the employer’s compliance with French law stating how options must be priced. Whew.
Key point learned: Continued uncertainty over the details of 409A creates an amazing minefield for companies pursuing even the simplest global equity plan designs. It’s ironic that many US firms failed in their attempt to export US-based equity plan designs to other countries, and now we are inadvertently exporting our tax rules, creating failures of otherwise successful plans.
Key terms you’ll need to know to converse on this topic: Four Oh Nine Cap A, transition rules, service recipient stock, permitted distribution, offshore funding.
Pleasing Institutional Investors – A Worldwide View
Damian Carnell and James Matthews of Towers Perrin (UK and US, respectively) presented a global perspective on a topic we read about every day in the US media: corporate governance - which is often manifested in stories about excessive executive pay. They point out, however, that the corporate governance movement had its roots decades ago in corporate scandals and actions unrelated to pay. In the US we are now accustomed to dealing with the influence of ISS and various institutional shareholders when seeking shareholder approval of equity plans. As one crosses international borders, the governance framework changes with varying reliance on legislation, regulation, stock exchange rules, and investor pressure, and disclosure. Also, I really liked their term “executive comp rehab” - not that any of my clients would ever need such intervention…
Key point learned: Interestingly, while many countries have incorporated their governance requirements into a single set of rules, the US has not, relying on a combination of stock exchange listing requirements, investors and proxy advisory firms’ guidelines, and various “blue ribbon” panels making it more difficult to understand just what the “rules” are particularly since many of them are in conflict with one another. You have to love the US’s free market approach to this!
Key terms you’ll need to know to converse on this topic: In the UK, ISS/RREV, Cadbury Code, Greenbury Code, Hampel Code, Combined Code, ABI, NAPF. There’s another set for each country and the list goes on.
Keynote: The Medici Effect: Groundbreaking Innovation
Frans Johansson (US)
I often miss the keynote general sessions but how could one not attend a session for which the introduction includes the teaser: “What do termites and architecture have in common? Music records and airlines? And what does any of this have to do with health-care, card-games or cooking? Most of us would assume nothing. But out of each of these seemingly random combinations have come groundbreaking ideas that have created whole new fields.” I thought I knew the unfortunate answer to the termites-architecture piece but found there was another angle I missed.
Mr. Johansson’s topic is particularly well-suited for a group of global equity professionals who come from a variety of technical backgrounds – accounting, tax, law, administration, human resources - and often stay siloed in their area as they think through equity compensation issues. We saw this over the past couple of years with the introduction of new accounting requirements for share-based payments (often labeled “option expensing”) that unfortunately have had a disproportionate impact on some companies’ equity plan designs to the exclusion of other financial considerations, strategic factors, and behavioral drivers. (Why, that’s exactly what I’m covering here in my presentation tomorrow at 2pm!) Diverse teams are the solution (Diversity Drives Innovation was a slide shown several times) says Mr. Johansson so I think that means that the accountants, lawyers, administrators, and even we consultants. need to step out of our siloes if we are going to provide innovative solutions for our clients and employers.
Key point learned: (1) All new ideas are combinations of existing ideas (2) People and teams that break new ground innovate and execute more ideas – the relationship between quantity and quantity of innovation.
Key terms you’ll need to know to converse on this topic: I think Mr. Johansson would prefer that you purchase his book to find this out (which you get for free if you attended this Conference). I already gave away his two key points and shouldn’t tell you his five key ideas for innovation.
Cops, Robbers, and Priests: Stock Plan Fraud and Ethics
Well didn’t these two - Carine Schneider (Smith Barney) and Emily Cervino (Certified Equity Professional Institute) - get lucky; one must choose one’s speaking topic many months in advance of the Conference and while stock plan fraud and ethics were already hot topics a few months ago, the recent scandals on stock option timing and backdating must have boosted interest in this session. Hopefully people didn’t misinterpret the fraud part of the title and think this was a “how-to” session as so many of the other Conference sessions are.
It actually was an excellent how-to session on the steps for avoiding becoming another poster child for stock plan fraud, a group which included in their session Cisco Systems, US Wireless, Mercury Interactive and HMT Technologies. I came away thinking that there is going to be a lot of blogging to do on this topic in the not-so-distant future.
Key Points Learned: I may be a bit sensitive on this point but the highest-fraud age group is 41-50 yet we, I mean they, are only third in the median value of frauds committed. The older the perpetrator the higher the median fraud amount – the over-60 group are the high performers here.
Key terms you’ll need to know to converse on this topic: Ends-based, acts-based, and duty-based principles; Section 302, Section 404, and – of course – SOX.
Someone will undoubtedly complain that while I listed the “key terms” I didn’t spell out the acronyms or define the terms. This is a blog, and if you were at the Conference today you’d already know!
Blog you tomorrow.
Monday, April 24, 2006
Sunday, April 23, 2006
Remember the caveat in my recent blog about how the media counts these numbers. A lot of the pay attributed to last year is the result of executives exercising options that are up to 10 years old and in many cases had to be exercised last year before they expired. These gains represent years of hard work, managing through the bubble and the bust, and are often reflective of significant long-term shareholder value creation. Case in point is the article in which I was quoted (misquoted actually, but that frequently happens) regarding Boeing. Even where that was not a factor, the continued adding of apples, oranges, and bananas gives us mixed fruit, not an accurate apple count. Many of the media stories that compare these pay numbers to last year’s share price performance are not only absurd but intentionally misleading because the writers and their consultants know better. Admittedly, there are overpaid executives in some companies, especially when company performance is considered (which requires matching the time period of pay with the time period of performance, not a simple calculation). In the past week, however, I have encountered some pay and performance issues myself, such as the cook at the restaurant that burned my little boy’s grilled cheese sandwich not once but twice (how hard can that be?). I’m a big fan of pay for performance and conclude that overpaid and underperforming employees are distributed throughout our economy, at all levels of companies, and often seem to be clustered in the businesses I deal with. They don’t have their pay and performance published in the paper but I’m happy to help spread the word.
These executives made a whole lot more than just about anyone reading (and certainly anyone writing) this blog. Some organizations are obsessed with calculating exactly how much more these executives earn than the so-called “average worker”. I am encouraged if some of those executives are reading my blog because I think they could learn a lot about some of the fascinating technical aspects of compensation, not to mention the added bonus of hearing my opinion, which is that comparing executive pay to that of the average worker is meaningless, distorted, and incites unwarranted anger.
Many executives are good negotiators, some have professional negotiators working for them, and others might be good buddies with those on their Board of Directors who have a voice in determining their pay. (We can gripe about that last point all day and won’t change the fact that business is often done among friends and always will be.) Many others were in the right place at the right time. But others are brilliant strategists and managers who have managed a complex multi-billion dollar multinational corporation in a manner that has created enormous value for shareholders, employees, customers, and our economy. Yes, CEOs make hundreds of times more than we average folks do. There’s a complex set of reasons for that and continually complaining about it will not get anyone a 20,000% pay increase – they could, however, start a company that ends up being worth $10 billion and then they might earn $10 million a year, too. That would require enormous effort which is what many of these executives have expended and they’re being paid for the results.
These stories dominate the business section this time of year which limits the number of interesting topics to write about, but this next item is keeping things interesting. At least a few of the individuals mentioned in the news items above may have received additional compensation, beyond what was intended by the formal compensation program, due to a questionable practice in how their options were granted. It appears some companies may have granted options on days when the share price hit a low, ensuring the options produced gains much higher than they might otherwise have. When they missed that opportunity, they may have simply backdated the options when they were granted later. The most recently accused include UnitedHealth Group (whose CEO has about $1.6 billion in option value – no I did not misspell “million”) and Vitesse Semiconductor. “Yeah, these options were really granted a few months ago before that big price run-up that I just made a lot of money on. Yeah, that’s right, that’s the ticket.” (If you weren’t watching SNL in 1985 you might not get the reference to the Pathological Liar character but it seems fitting.)
I blogged about this earlier this week. We thought that after Enron, Sarbanes-Oxley, and a number of CEO perp walks that these kinds of things wouldn’t happen any more. Oh well, let’s roll out some additional legislation shall we? No, let’s just jail the crooks, if in fact a crime was committed, and not blame the problem on stock options. It’s costing Americans too much money to continue having these scandals eroding the confidence of US companies in the world’s capital markets.
Some companies reacted to these disclosures by either putting the individuals suspected of the behavior on “administrative leave” or by promising not to do it any more. I’m not sure but I think that if I had done something similarly unethical and illegal my leave might be much more than merely “administrative” – probably more along the lines of “incarcerative” and “refund-ative” (c’mon, that’s no worse than calling it ‘option-gate’ which some journalist inevitably will do.)
Pardon my tongue-in-cheek tone today, but reading a week of these kinds of headlines, for one who is dedicated to the field of compensation – and dedicated to professional integrity – requires maintaining a sense of humor about it at times. Too much time is spent on superficial numbers and analyses and not enough time on the real issues. Sometime soon I’ll write about the various “golden parachute” and severance deals that have produced some very excessive compensation for some very inadequate performers so that we can understand the real problems that need solving. Here’s a previous blog describing one example.
I be posting next week from NYC at the Global Equity Organization (GEO) Annual Conference where I will have to be very brief because I must spend less time blogging and more time attending critical events like the evening receptions. As everyone knows, that is where the real work gets done and I have a job to do. Maybe I’ll add a gossip section to the blog - though I wonder how compelling gossip among global equity professionals could really be: “I can’t believe what they did with their option term! This won’t help them a bit with their FAS123R expense and there were better ways to deal with ISS’s concerns on their plan.” This might set me up to say something like “you had to be there.”
Friday, April 21, 2006
Shameless plug: My presentation is Friday afternoon, titled "After the Fall (of 2005): What Really Happened with Option Expensing in the US." The slides from that presentation will be posted on my website. This session presents our research, updated daily, on what companies have really done - and not done - in response to new equity compensation accounting requirements (fondly known as FAS123R).
You can visit this blog or go to the GEO site to access the daily news I'll be reporting. For other breaking news on HR-related issues you can visit the HR MegaBlog, which posts all new entries from this blog, or see my column on HR.com in the Areas of Interest: Compensation section.
Wednesday, April 19, 2006
As I discussed in my Compensation Integrity blog on April 19, the latest compensation scandal over the timing of stock option grants has created shock and awe. Would corporate executives and members of boards of directors really time the granting of options to catch stock price lows and ensure additional gain from those options? Or worse, would a company backdate an option grant? Would a company then try to make amends when record-setting option gains are suspected of being a result of such practices? Or would that just be too darn obvious?
Yesterday's news included the story that UnitedHealth Group is suspected of this behavior and the CEO has called for a halt to all equity grants to executives plus capping some other noncash perks and supplemental executive retirement benefits. I would just love to be the person who gets to do the calculation to see if these "givebacks" are comparable in value to the alleged ill-gotten gains from the purported option granting practices.
Other companies have recently been caught doing something similar, including Vitesse Semiconductor, and I can tell you there are many, many more. What is most surprising to me is that so many companies have been doing this for so many years, and so many company employees were aware of the practice, yet it took investigative journalism years later to uncover it.
My clients often ask about "creative" compensation plans or how to do something "innovative" with their compensation programs. I tell them my view is that "creativity" is applying an existing solution to a new problem (like using a paperweight for a doorstop), while innovation is developing a new solution to an old problem (inventing a device that holds paper to your desk and keeps your door open at the same time). If the accusations are true, I think these companies were not creative but were quite innovative in finding a way to prevent underwater stock options and ensure the maximum "bang for the buck" for each option granted. But like developing an innovative way to rob money from a bank, or even creatively robbing a bank, it's illegal and it's wrong.
So please, let's not again conclude as many did after the Enron debacle that stock options are the source of the problem. That would be like closing all banks to prevent bank robberies. Let's instead make sure that the penalty for bank robbers is not just that they have to promise not to rob any more banks and offer give back some of the money they stole from robbing amored cars. Our jails might be overcrowded but there's always room for one more billionaire.
The solution to these recurring instances of abuse of otherwise sound compensation practices is well-documented and accepted by many organizations: an active, informed Compensation Committee of the Board of Directors that resists "one-off" deals and "exceptions" and has a formal calendar of meetings and actions prepared in advance of the year. With those things in place, the alleged UnitedHealth situation could never happen and if it looked like it did there would be ample documentation to the contrary. Absent such practices and policies, however, it might look like someone got a little too creative, or innovative, or maybe just greedy.