The 9/11 options

Today's WSJ has the latest in its overblown series on stock option. It reports that

from Sept. 17, 2001, through the end of the month, 511 top executives at 186 of these companies got stock-option grants. The number who received grants was 2.6 times as many as in the same stretch of September in 2000, and more than twice as many as in the like period in any other year between 1999 and 2003. Ninety-one companies that didn't regularly grant stock options in September did so in the first two weeks of trading after the terror attack. Their grants were concentrated around Sept. 21, when the market reached its post-attack low. They were worth about $325 million when granted, based on a standard method of valuing stock options.

Although the story raises the specter of more backdating (to 9/21), that's not the gist. Nor, of course, is this about insider trading. Rather, the reporters ask "Did companies take unseemly advantage of a national tragedy?"

To begin with, unless the companies were backdating they weren't taking advantage of anything just by awarding options in the wake of 9/11. Although these prices look low now, think back to 9/17. Anything could have happened then, particularly including more attacks, or slower recovery from the horrendous ones we had just had. I remember actually being happy to hear about the Enron scandal breaking in October that year because stories about corporate fraud were something more like normal life.

Sure, one could tell a story about behavioral finance and investors overreacting. For my thoughts on all that, see my Fraud on a Noisy Market. But while you can construct all kinds of scenarios about overreacting after the fact, it's hard or impossible to make money on any of these theories by investing before the fact, even if you're a corporate board or a ceo.

Maybe this is back to "optics" -- -- whatever was really going on, directors must pay attention to how it looks. It's 9/11, they should be grieving, not thinking about how to fill their wallets with filthy money.  Please. One reason our markets were so resilient is because we had managers who were focused on money.  Should they have been thinking only about how to fill the shareholders' wallets with the nasty stuff?  So what we really want from our corporate executives is people who are greedy enough to be thinking about money after 9/11, but altruistic enough only to be thinking about how to make it for the shareholders?  Aren't we getting a little picky?

So what's left to complain about? First, it is unfortunately probably the case that the managers thought their stock was a "bargain." I wish corporate managers did believe more in efficient markets, and really internalized the notion that stocks go up because real things change, not because of graphs on stock charts.

Second, there is the simple fact that, for whatever reason, executives did get $325 million in compensation for no apparent reason. This works out to about $1.8 million per company. It's not small change, but is it front page news six years later? Moreover, this number overstates the actual cost, because whatever we think about greedy and dishonest executives, we simply can't assume no substitution for later at-the-money grants or other compensation that would be no less costly for the company.

Finally, the biggest problem of all. There's a sort of journalist dishonesty here I've called "cooking the journalistic books." The whole backdating/springloading story has had the aspect of the mutual fund "scandal" -- leveraging a bunch of tangentially related stories involving quite disparate practices into one big scandal that keeps the readers coming back and buying newspapers. The last thing the journalists want is the sort of analytical clarity that we need for useful public policymaking. Rather, they want to obfuscate differences to enlarge the apparent, though not actual, size of the story. With respect to the 9/11 "scandal," the reporters can add to the usual book-cooking large dollops of greed-and-resentment-mongering curried in sanctimony.

Comments

[Mukund Mohan]

Larry
It does stink of fraud. There are a couple of things to note though.

1. Before 9/11 tech stocks in particular were on the low following the DOT COM explosion. So these executives were given options at a logical low point

2. It has taken 6+ years and lots of research work by Erik Lie to uncover these items, so I wont blame the reporters or WSJ to take their time to publish these issues. I diagree that they are just trying to keep the public's attention.

Options Backdating Blog http://blog.vangal.com

[Marc Hodak]

Fraud is an ugly and inappropriate word here, but I'm certain that more than a couple of the companies involved will now find themselves in the uncomfortable position of denying that they were "taking advantage of a national tragedy" (or, as I prefer to put it, following the Rothschild "blood in the streets" investing advice)...because they were actually backdating!

Anyway you spin this, it certainly doesn't look as statesmanlike as, say, buying the company's shares up front. Then again, I'm sure that happened, too, but obviously doesn't make as good a story.

[Robert Schwartz]

Actually the market didn't hit bottom until the second half of 2002 and first quarter of 2003. But its had to be emotional about a recession.

[Barry Ritholtz]

Hey Prof,

Executives had an opportunity to step up at a moment of national crisis. It was one of those occasions where great men rise to the occasion, while lesser men look not to be a great Americans or patriots, but something else.

As a group, the 511 execs at 186 companies chose "something else."

They could have been patriots in the manner of JPM and others. Instead, thy elected to embody the cliche: "The problem with capitalism is the capitalists." As corporate execs, THEY DID NOTHING FOR THEIR SHAREHOLDERS. They lacked the courage to buy stock with their won money, choosing instead the path of riskfree options.

As a hedge fund manager who in part makes purchases based on my evaluation of how well CEOs treat shareholders, its quite revealing as to this group of execs' priorities (and ethics) when it relates to their bosses -- THE SHAREHOLDERS.

Its dissappointing to see Law School profs acting as apologists for this group.

This is not about how it LOOKS -- this is about what happened at a specific moment in history -- what it revealed about some people's character, priorities and ethics. Don't fall into the trap of confusing what is "legal" with what is ethical.

[abhcoide]

Well said Barry. You hit the nail on the head.

Larry, stop being an apologist for people who will never have your interested at heart. No matter how you dress this up it wasn't about the greater good or the people they are susposed to protect (and work for) the shareholders. They weren't doing their jobs they were trying to profit personally from disaster. Legal yes, ethical definitely not.

As for "legal", hmm, well having studied American business law (am an Attorney at Law (New York) but I practice in Ireland, it might be more nuanced than that, they are fiduciaries and owe duties of disclosure...so arguments could be made if they had failed do disclose this to the shareholders (I'm not sure of whether they did or did not disclose this...I'll tried to find out elsewhere.