Friday, October 23, 2009

Another Example of CEO Compensation Run Amok?

Drexel University Professors Eliezer Fich, Jie Cai and Anh Tran have authored a research paper and study that purports to show that Chief Executive Officers of companies targeted for takeover routinely receive unscheduled option grants during private merger negotiations that serve to enrich the CEO's at the expense of their company shareholders once a merger is consummated. The paper, entitled "Stock Option Grants to Target CEOs During Private Merger Negotiations," describes its purpose and findings as follows:

"Abstract: Many publicly traded targets grant their CEOs unscheduled options during private merger negotiations. Such grants, which become exercisable when acquisitions consummate, are systematically timed to benefit target CEOs. Such favorable timing persists even after Sarbanes-Oxley passes. Conversely, we show that the same target CEOs negotiate lower than expected acquisition offers. Consequently, shareholders of targets that grant their CEOs unscheduled options during private merger negotiations lose about 307 million dollars when their firms are sold. These losses trigger non-trivial wealth effects; on average, target value drops by 54 dollars for every dollar target CEOs receive from these unscheduled options. Our results have public policy implications related to executive compensation, corporate governance and securities laws."

As merger and acquisition activity has resurfaced in recent months after a period of dormancy based on the global meltdown, this CEO enrichment practice seemingly continues unabated. At bottom, this study suggests that CEOs are being incentivized to consider takeover overtures from potential acquirors through the grant of options that allow million dollar paydays once the CEO considers, accepts, negotiates and consummates a merger. But why incentivize a CEO that should be acting in the best interest of his or her shareholders by seriously considering all takeover overtures that may benefit the corporation's shareholders? Additionally, the study suggests that the CEO that receives the unscheduled option grant is less vigilant in negotiating the best takeover price for shareholders as presumably he or she is working to protect the million dollar payday by ensuring that the acquisition closes, rather than negotiating hard with the acquiror by pushing for greater value for shares.

As reported in the Wall Street Journal last week, in June 2009, top executives at Omniture Inc. received new unscheduled options just weeks after the software firm received takeover feelers from Adobe Systems Inc. Adobe eventually agreed to buy Omniture for $1.8 billion with profits to the top Omniture executives tallying $9.7 million on their newly granted options.

Marvel Entertainment Inc.'s CEO stands to reap $34 million from unscheduled options granted to him in the weeks after acquisition talks were opened with the Walt Disney Co., that ultimately led to the consummation of a merger between Disney and Marvel.

According to the Wall Street Journal: "For shareholders, such grants can cut two ways. Critics say that insiders at some companies are unfairly benefiting from nonpublic information, and that issuing extra shares to executives dilutes the value of existing shares. On the other hand, such options could provide further incentive to executives to entertain takeover bids, benefiting all shareholders."

I find this WSJ explanation outrageous. Granting unscheduled stock options to top company executives is necessary to incentivize executives to actually entertain takeover bids, thus benefiting all shareholders?! It is a fiduciary responsibility of corporate executives to entertain takeover bids. If additional compensation is necessary to provide incentive to caretake an important fiduciary responsibility, then we have truly lost our way in connection with executive compensation.

Once again, are Corporate Executives and Corporate Boards, enriching themselves at the expense of the shareholders they are charged to represent and protect? This study certainly seems to indicate yet another example of CEO compensation run amok.


  1. fortune magazine takes a swipe at the age old wall street argument "if we don't pay, then our best talent will leave" by suggesting that the "best talent" has performed abysmally. see:

    godspeed to the "best talent" is what i say.

  2. It seems the SEC has a new slogan "Too big to charge." SOX provided more arrows in their quiver, specifically designating any violation of SOX as creating liability under the S&E Act of '34. The SEC continues to hide behind the fact that an option is not considered a purchase of securities under the '34 act. Perhaps the SEC needs to be reminded that SOX was intended to do more than just rotate accountants around. Reminiscent of the backdating scandal of 2006, the SEC failed to notice despite numerous articles pointing out the problem. Perhaps, the SEC should take a course in spreadsheet modeling and then these seemingly impossible to notice coincidences would become clear.