Monday, December 18, 2006
Posted by Jeff Lipshaw
Several days ago, I commented on the assumptions by which Professors Bebchuk, et al., constructed their data set for the "Lucky CEO" study - which purports to show that stock option grants to CEOs too often fell on the date of the lowest trading price of the month (or the quarter in the case of "super-lucky" grants) to be mere coincidence. Hence, the authors infer not just causation, but a particular kind of causation - there must have been backdating or something like it.
The same group has now issued a second paper entitled "Lucky Directors," and is making the same point, but now more broadly about option grants to independent directors. I had made the point earlier that the first paper seemed to assume many grants as unscheduled that, in my experience, would otherwise be considered scheduled.
Having now done a quick thumb through this second paper, it looks to me like we have a similar issue. The authors state: "Practitioners with whom we discussed the subject told us that in their view, director grants have been unlikely targets for opportunistic timing because many of them coincide with the annual meeting and because the monetary stakes are substantially smaller than in executives' grants." (Paper at 2). Accordingly, we find that only certain grants are excluded as scheduled: "Some firms provide grants to directors on the date of the annual shareholder meeting. These grants are scheduled in advance, and they thus cannot be expected to be the product of opportunistic timing. The Investor Responsibility Research Center (IRRC) database provides information on the annual meeting dates for a subset (about 25%) of the firms in our sample, and using it we are able to identify 2,555 grant events (about 9% of the total) that fell within +/- one day of the annual meeting."
As I read this, the ONLY grants excluded from the ten year study as "scheduled grants" are the 9% of the option grants for the 25% of firms for which an annual meeting date could be identified. Interestingly, the authors concluded that there is no evidence of non-random pricing as to these grants.
Once again, I find myself stepping back to do a sanity check. Do the authors really think it is plausible that 91% of all directors' option grants were unscheduled? I was surprised to learn that director option grants were considered scheduled only if granted within one day of the annual shareholders meeting. As I pointed out in the previous post, the board can, and usually does, grant options at regularly scheduled directors' meetings, and those are far more frequent than the once a year shareholders' meeting. And for all we know, there are more firms that issued option grants on annual meeting dates not retrievable.
To repeat, I don't know how the statistics would come out if the sample set assumptions were different. It seems to me plausible that the data on other "scheduled but deemed unscheduled" grants would come out just as random as those for the "annual meeting grants." It certainly bothers me when this very preliminary, unquestioned, and untested study supporting a particular agenda is quickly released to the Wall Street Journal and other media.
Moreover, I suppose one might chalk up these assumptions to the possibility that the authors are just not familiar with the way boards work. But the authors must know something I don't to be able to proffer this study as support for an op-ed in the Financial Times to the effect: “The patterns we have studied reflect persistent, widespread and systematic governance problems: the existence of incentives to provide executives with increased compensation below the radar screen; the prevalence of pay-setting processes not geared to maximise shareholder value; the the failures of internal monitoring systems.”
Maybe 1,400 directors deserve to be tarred. But I still can't tell from this data.