Exploring Corporate Governance Around the World

By Allison Garrett, Senior Vice President for Academic Affairs at Oklahoma Christian University

Wednesday, June 21, 2006

Spring Loading Options

I've blogged previously about the options scandals that are unfolding here, here and here. The LA Times published an article yesterday about another unsavory options practice: spring loading. This is the practice of granting options just prior to a company's announcement of good news. The company's stock price jumps up when the good news is announced, meaning that the options are almost immediately in-the-money.

Even though the compensation committee votes to grant the options, spring loading really isn't much different than insider trading where a company executive who has material non-public information buys the stock just prior to the public announcement. If the information is good news, the stock price is almost certain to increase and the executive will profit.

In this case, the executive must hold onto the options until they vest. Presumably, when they do vest they will be in the money and the executive can exercise the options and make a profit. Arguably, in some small measure, at least, the good news that was issued just after the options were granted is in some small measure still part of the mosaic that goes into the stock price.

Who has been hurt by this practice? The market? The company? The shareholders? Arguably, all of them. The market is hurt because the practice, if not fully disclosed, means that the market did not take into account all material information in valuing the company's stock. And many would say that a company's compensation practices are material.

With backdating, companies may have to restate earnings because they should have recognized compensation expenses at the time of grant. I don't see a similar accounting or tax issue with respect to the practice of spring loading (caveat: I am neither an accountant nor a tax lawyer). Of course, companies that engaged in this practice may see a loss of investor confidence and might be the target of lawsuits charging them with filing false and misleading proxy statements.

What about the shareholders? The shareholders have a right to be angry about this sort of practice. After all, the officers now have a right to buy shares at a price that did not take into account the subsequent good news. If the company engaged in this practice and did not make full disclosure, then shareholders may sue the company for filing a false and misleading proxy statement.

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