CEOs Beat the Odds With Stock Options

by James Parks, Apr 5, 2007

Your odds of winning the lottery with a $1 Powerball ticket are one in 146 million. But if you are a corporate CEO, you can almost guarantee you’ll hit the jackpot several ways by rigging the system to get a perfect payday.

One of the more popular ways CEOs beat the odds has involved backdating the stock options their corporate boards granted them, picking a date when the stock was trading at a lower price than the date of their options grant, resulting in an instant profit. Many CEOs did just that last year in what has become the biggest executive pay scandal in decades.

According to the AFL-CIO’s 2007 Executive PayWatch website, released today, 257 companies have announced internal reviews, Securities and Exchange Commission (SEC) reviews or Justice Department subpoenas related to stock option grants.

This year, the PayWatch website features case studies of CEOs who backdated stock options to take what they want from their companies and their shareholders with impunity. The case studies highlight the need for reform to protect companies and their investors—and the PayWatch site makes it easy for users to contact the SEC and member of Congress to urge new rules governing executive pay.

In 2006, the average CEO of a Standard & Poor’s 500 company made $14.78 million in total compensation, according to initial estimates. Where available, this year the PayWatch site includes some of the executive compensation data required under new rules issued by the SEC in 2006. The new disclosure rules go further than ever before in revealing just how much executives are paid, making transparent previously hard-to-find information such as pension totals.

But a last-minute change in the rules weakened requirements for disclosure of stock options. The new PayWatch site will provide, in comparison with the SEC provided total, the total compensation an executive received that includes the total value of stock and option awards granted in 2006, giving a better representation of what the CEO was awarded in 2006.

Unlike the employees who work under them, CEOs often are allowed to resign with big pay packages even if they don’t do their jobs well. For example, Home Depot CEO Robert Nardelli resigned in January, claiming he was owed more than $200 million in severance payments, even though the company’s stock prices has dropped during his tenure. Pfizer Inc. CEO Henry “Hank” McKinnell gets a retirement package worth $6.5 million every year, despite the company losing more than $50 billion in market capitalization while he was at the helm. (Market cap is the number of common shares multiplied by the price of those shares.)

Through six case studies, including Home Depot’s and Pfizer’s, the site shows how executives benefited from large severance packages and stock option backdating at the expense of companies and their shareholders:

• The Apple Inc. case study explains that Steve Jobs’ $1 salary was more than offset by his past equity awards, including stock options that were backdated, and that Apple has been less than forthcoming about Jobs’ involvement in any improper backdating.
• The Caremark Rx Inc. case study shows that large golden parachutes can be an incentive to propose mergers that are not in the best interests of shareholders. According to preliminary estimates, CEO Edwin Crawford could get a severance package worth up to $287 million.
• At KB Home, former CEO Bruce Karatz could receive an exit package worth as much as $175 million, despite his involvement in the backdating of stock options. Though KB Home is still in discussions with Karatz over what he will actually receive, the company has made its case more difficult if it decides not to pay him because of his employment agreement.
• Former UnitedHealth Group Inc. CEO William McGuire received 14.6 million shares in stock options on the same day the company’s shares fell to their lowest price for the year—Oct. 13, 1999. In addition, grants in several other years occurred near the bottom of sharp stock dips. McGuire denied he backdated his options—but the odds of all of those events occurring were one in 200 million or greater—much worse than his odds of winning the Powerball. The result? Over his 15 years as CEO, stock option backdating helped McGuire accumulate more than $2 billion in stock options. McGuire’s retirement status and stock options are frozen pending a special review.

Speaking to reporters today, AFL-CIO Secretary-Treasurer Richard Trumka said:

In the past year, we have seen scandalous examples of stock options abuses at hundreds of companies. Plus, we’ve continued to see runaway executive pay and exit packages.

Corporate directors, our representatives, are failing in their responsibility to police CEO pay and align it with performance. Even a majority of directors now recognize there is a problem; 61 percent of corporate directors think the current system has overpaid executives. From conflicted compensation consultants to cowering boards, the current CEO pay system is badly broken.

Working people are fed up with a system that showers CEOs with lavish rewards with little or no accountability. When the board is failing in their duty, investors should have the tools to bring about real reform.

Trumka also told reporters the AFL-CIO will build on last year’s successful corporate governance proposals at Pfizer and Home Depot by focusing its attention on Verizon. The Verizon CEO, Ivan Seidenberg, has raked in more than $109 million in the past five years, despite a total shareholder return of negative 5 percent.

“Through a ‘Vote No’ on Verizon’s compensation committee and three important shareholder proposals, we will lead the effort to clean up this company’s governance,” Trumka said.

PayWatch’s database of CEO pay is searchable by company name, ticker symbol, industry or total compensation. Since the first annual PayWatch site was released in 1997, more than 22 million visitors have used the website to track data on CEO pay and the corporate abuses that cause it to soar. Another popular feature of the site lets you compare how your salary stacks up against that of major CEOs.

Want to take on corporate greed? You can urge your representatives to support H.R. 1257, the Shareholder Vote on Executive Compensation Act. Introduced by Rep. Barney Frank (D-Mass.), chairman of the House Financial Services Committee, the bill would require public companies to submit executive pay plans to a nonbinding shareholder vote, giving shareholders a “say on pay.”

A shareholder voice in the executive compensation process will encourage boards of directors to consider shareholder interests before approving questionable compensation plans. Click here to urge your representative to support a say on pay.

Then you can encourage the SEC to allow long-term shareholders to nominate directors and require companies to include these nominees on the company’s proxy ballot, which will end the self-perpetuating system that permits incumbent boards to hand-pick director candidates, making boards truly accountable to shareholders. Click here to urge the SEC to allow proxy access.   

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