Friday, June 16, 2006

Microsoft forward dated option awards... even to directors!

..and yet they didnt think to question the practice?!

Well, I suppose we should give them a break. Somebody must have raised some objections, because they abandoned the system in the late 1990s.

For those still confused about backdating vs. forward dating, here's the deal:

Say on June 1st, company X decides to give an employee stock options. Ideally, they should award the options with an exercise price thats equal to the stock price on June 1st.
The companies involved in the backdating scandal however, picked a date which had the lowest stock price in the previous quarter (or year, or month) and awarded it retrospectively on that date - say, May 4th.

Microsoft, however, after deciding to award the stock options to the employee on June 1st, goes on to wait and see for the next 30 days. Then it awarded the option with an exercise price equal to the lowest stock price in the next 30 days - say, on June 13th. Hence "forward" dating.

Whats the difference? A Microsoft spokesperson in an article today claimed that there was nothing wrong with what they did. However, lets examine the incentives at work here.
The employee at Company X was happy to receive a stock option which locked in an instant gain on the day he received it. This did not motivate him to work hard enough in the next year or so, because the locked-in gains were substantial as it is and unlikely to get much larger.

The employee at Microsoft, however, from June 1st onwards, was probably constantly looking for the stock price to DROP in the next 30 days (though of course he would look for the price to rise again subsequent to the 30 days). One may say that this in fact gives the employee a conflict of interest with the company!
Instead of simply being not motivated to work hard for the company (like employee X), the Microsoft guy's incentives were aligned to profit him if the company does poorly in the first 30 days !

So contrary to Microsoft's claim that they 'did nothing wrong' I would say that their actions were far more harmful to the company than the actions of all the (45 plus?) companies involved in the backdating probe.The only redeeming factor about MS being that the practice was stopped soon after it was begun in the 1990s.

No comments: