A Little Hard on the HR Profession, Huh?

Fred Whittlesey
Compensation Venture Group, Inc.

That was the one-line email I received after sending my article "The Governance Implications of Option Backdating," just published in the Corporate Governance Advisor, to a client of mine. He happens to be the SVP of HR. I won't post the entire article here but rather will refer you to the publication's website and will post the section that led to my client's comment:

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Where was HR in the Governance Process?

“How could this have happened?” continues to be asked. Just this week, one human resources (HR) publication suggested that the human resources function – which as a group seem to be continually looking for a way to attain a status on par with their financial and legal peers – should serve as the internal watchdog for option granting practices.[i] In at least one company, however, HR was not only failing as watchdog but was the fox in the henhouse.[ii] If HR is taking the stance, or supporting other managers’ stances, that “everybody’s doing it” or “we need to do it to be competitive” then they failed at one of the few ways that HR can really add demonstrable value. That lost potential value is easily seen in the accumulation of costs now being experienced by these companies.

The overwhelming cost being incurred by some of these companies to correct accounting, legal, and tax problems (plus any employee financial issues) shows that HR may have acted as a “cost center” than anyone imagined. The cost of certain option redemption programs alone arguably exceed any value that the HR department could ever add.[iii] Add to this the increased cost, and perhaps restricted availability, of Director & Officer liability insurance coverage; the impact on valid options that are now underwater due to share price declines; the associated turnover and difficulty recruiting; the list goes on.

If HR argued that it was a matter of employee morale in volatile stock price companies, as appears to be the case at Microsoft and Micrel, HR failed because there are ample solutions to this concern without violating rules and laws. It now appears that merely paying employees additional compensation in some form may have been a much less expensive approach to dealing with volatile strike prices than the creative but disallowed option timing and pricing tactics.

Since the passage of Sarbanes-Oxley, there has been a continual migration of tasks and functions out of the HR department to the finance and legal areas, and to outsourcing firms. The backdating situation highlights the need to ensure that any task with mission-critical financial impact is managed by financially competent professionals with appropriate Board oversight. We now have confirmed that putting option grant processes in the hands of recruiters or HR managers can be a recipe for disaster.

[i] “Stock Options Scandal Might Put HR in Watchdog Role”, Workforce Management, August 5, 2006.
[ii] U.S. v. Gregory L. Reyes and Stephanie Jensen, July 20, 2006.
[iii] Brocade Communication Systems, Inc. Tender Offer as disclosed in Tender Offer filing 005-5697706908006, May 12, 2006.

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(Wow, Blogger has nice code, even the footnotes automatically transferred in from a simple copy-paste out of Word of the referenced text. Pretty cool.)

My response to him? "Yes, but most of them deserve it, present company clearly excepted" which is the case on both counts.

Was I a little hard on the HR profession? Probably not nearly as hard on it as the current stock option scandal is going to turn out to be.

In closing, I suppose some of these option backdating companies' actions qualify them for a spot in the Stupid Compensation Plans file, but I won't add further insult to the extensive injury they're experiencing. [Stand-up comics would call that a "callback" (see my most recent blog) but this situation isn't funny and there needs to be some real change in compensation management processes.]

By the way, have you noticed how many companies now have the head of compensation and benefits reporting to the CFO, rather than the VP of HR? Hmm. A little hard on the HR profession, huh?