How to raise executive pay on behalf of earnings

November 06, 2005|By JAY HANCOCK

Even after trends collapse and eras end, history trickles into the future.

Hadrosaur dinosaurs apparently walked New Mexico long after an asteroid wiped out their cousins. The 1960s ended with Kent State and the Beatles' breakup, but people ate hallucinogens and wore goofy hairdos in the Carter presidency.

Now the 1990s return as fallout from the burst stock bubble. Corporate executives are carting off undeserved pay, profits are being gamed, and Wall Street doesn't care.

Specifically, corporations are shoveling extra stock-option booty into the trunks of their executives' Lexuses this year to try to beat an accounting-change deadline.

As of Jan. 1, most public companies must start deducting stock-option expenses from their reported profits. By porking up now on options benefits that they otherwise wouldn't have gotten until later, executives can enhance their companies' reported earnings for next year, take a penalty-free expense for THIS year and boost their pay.

It's a win-Win-WIN! Except for shareholders, who, when the accounting fog is brushed aside, suffer potential dilution to their ownership that wouldn't have happened otherwise.

"Accelerated vesting," it's called, and hundreds of companies are doing it, including Ciena, Sun Microsystems, Comcast and Tribune Co., owner of this newspaper. (Tribune says its topmost bosses didn't participate.)

Accelerated vesting involves stock options that have been issued but can't be cashed yet.

In the options craze of the 1990s blamed for motivating some executives into accounting shenanigans, not allowing employee/recipients to exercise options for three or four years was supposed to encourage them to stick around.

But now, as the accounting-change deadline looms and stock options lose favor anyway, companies are scrapping the vesting schedule and allowing people to exercise options that wouldn't have gone live for years.

That way they avoid having those securities vest after Jan. 1, which would have required big expense deductions and lowered reported earnings. Forking over the options before Jan. 1 requires no such inconvenience.

It's not a fleece vest; it's a "vesting fleece" of shareholders that should be this winter's top fashion, says Jack Ciesielski, the Baltimore-based publisher of The Analyst's Accounting Observer. He calls accelerated vesting a legal "end-run around" of the new accounting rules, and counts 375 companies announcing accelerations through September.

Almost all the accelerated options, Ciesielski says, are out of the money, meaning the "strike" price is above the market price.

That's why many companies minimize the consequences. What's the harm in releasing an option to buy at $10 when the stock is trading $2? they ask. It's meaningless.

But it's not. Even out-of-the-money options hold value. People pay cash for such things every day on the Chicago Board Options Exchange because sometimes stocks go up. Recording these options' value as a corporate expense - to make up for 1990s laxity and yield a better picture of profits - is the whole point of the accounting change.

Ciesielski estimates that accelerated options announced through September are worth close to $3 billion.

Executives - many of the recipients appear to be officers and directors - are getting this compensation long before they would have under the original schedule. And many wouldn't have gotten it at all if they leave their companies in a year or two. The time value of money makes early vesting worth more, too.

Ciena, a Linthicum-based networks company, disclosed an accelerated vesting program last month.

Directors, officers and other employees were vested with 14.1 million out-of-the-money options, representing 2.4 percent of shares outstanding.

Spokeswoman Nicole Anderson said she doesn't know what acceleration portion went to directors and top executives, but don't worry about them. On Friday Ciena disclosed millions of NEW options and restricted shares for top bosses.

Some of the old, accelerated options can be exercised at a price of only $2.50. That's below Friday's close of $2.52 for Ciena's stock, which has risen enough in the two weeks since vesting to put them slightly in the money. The average strike price for all options is $4.39, and they don't expire for years.

Clearly they are worth something. Ciena said the acceleration would save it from booking $21.5 million in future costs. But it will deduct nothing from profits for vesting now. Only a footnote will tell the tale.

Someday Major League Baseball will crack down on performance-enhancing drugs, declare a new era and set a deadline for compliance. Players will keep using steroids up to the deadline and put up big numbers. But that won't mean the results aren't juiced.

jay.hancock@baltsun.com

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