Optics liability?

Suppose a company through an informed and disinterested board has awarded options backdated to a low-price day or springloaded to beat good news about to be released to the market. Further assume that the company adequately disclosed and accounted for the compensation according to applicable rules. Any problems?

Geoff Manne and I question whether these sorts of transactions involve bad business judgment. Moreover, I have said that the springloading doesn't involve illegal insider trading. See also the further discussion here. (I disagree with Bill Wang’s conclusion that the courts would today find insider trading based on breach of a duty to disclose to the shareholders in a public market situation. But in any event my example doesn't involve these facts.)

Suppose I’m right so far. Now suppose the company does it, and gets a lot of bad press. A shareholder sues the board derivatively on behalf of the corporation claiming that, even if the compensation itself was not a breach of the business judgment rule, the board should be liable for failure adequately to consider that journalists, academics and others would think this was a bad and sneaky thing to do, raising doubts about the firm’s honesty. Should the action survive a motion to dismiss?

Elizabeth Nowicki apparently thinks so:

Failure to discuss at length the “smells bad” issue (or the “potential illegality” issue) before awarding the options cannot be an act in good faith.

It is obvious that a board of directors does need to consider what might be called the “optics” of corporate actions. The question is whether it is bad faith (or absence of good faith, if there’s a difference) to fail adequately to do so -- that is, whether the failure should lead to liability.

Here’s the long answer: No.

Here’s the explanation: Disney.

This example makes it even clearer why the Delaware supreme court reached the right result. Directors have enough to worry about without also having to worry about whether “optics” will not only make the firm smell bad (to mix metaphors here) but land them in court -- and possibly avoid otherwise beneficial transactions because of this concern.

I understand that Elizabeth is not saying the board should be liable for reaching the conclusion they did, but only for failing to discuss the optics.  But how much time must boards then allot to optics discussions?  Given that their time isn't infinite, I think we can assume that other things won't get discussed, such as how the firm actually might be making more money.

Here’s a better suggestion: Instead of obsessing about the directors' optics, perhaps we should worry more about the blindness of business journalists and other opinion leaders to the underlying business motivations for corporate decisions.

Comments

[Jeff Lipshaw]

This reminds me a little bit of the line you hear about 11% of the time after a baseball player makes a great defensive play, and then bats first in the next inning: "isn't it amazing how a guy makes a great play and then comes up to bat first in the next inning?"

This issue, it seems to me, could be likely settled by some empirical work. My experience (admittedly anecdotal) is that companies grant options once a year as part of the overall incentive compensation plan. The option grants are approved, say, at a Friday board meeting in February, and the strike price is set at the closing price from the previous day. (Other options granted during the year tend to be in connection with recruiting new executives - you might give X options to Ms. Right as a sign on bonus.)

So it's a little like the 10b-5-1 plans, by which you infer there was no insider trading because you have set up a pre-existing and fixed plan to trade. Take a look at a sample of companies and see how many grant their options regularly at the same board meeting every year. See how many call special board meetings to make option grants. I have no idea what the answer is, but my guess is that the vast overwhelming majority issue options on a calendar, not a "special event" basis, and just by sheer luck, some are going to look spring loaded.

One of the comments somewhere about the vesting period reminds me of something else. I put some money with an investment advisor several years ago, and got a little brochure about trying to time the market when you are investing on a long-term basis. They used a character they called "Louie the Loser" who somehow managed to put all his money into the money every year at its peak. As I recall, if you studied this over ten or fifteen years, the differential in the return between Louie the Loser and somebody who invests at the bottom of the market every year is only a couple hundred basis points.