Gimme that marshmallow

PrudentBear ^ | May 26, 2006 | Rob Peebles

[l33t]

Back in the ‘60s when lots of people were experimenting with lots of things, a Stanford professor was experimenting with marshmallows. In his now legendary study, Walter Mischel gave children a single marshmallow, but explained that if they waited to eat it until he returned to the room, he would give them a second marshmallow, and then they could eat both.

Naturally, some kids didn’t wait for the second marshmallow, preferring to eat the first one as soon at it hit the desk. But others, even at the age of four or five, were able to hold off long enough to earn a second treat.

It was probably interesting enough to watch kids squirm in their seats while waiting for the nice man in the white lab coat to come back into the room with the goods, particularly in the days before Gummy Bears and Reese’s Pieces, back when a marshmallow was a real treat and not something you shot out of a toy at your sister.

But the experiment became even more interesting when Mischel checked on the kids years later. He found that those children who had waited for the second marshmallow had better academic and social skills than those who yielded to instant gratification. In other words, a child’s ability to delay gratification appeared to increase the odds of success later in life.

Today’s CEOs certainly understand the marshmallow concept. That’s why many have stock option plans that will make them rich if they work hard and improve the fortunes of the company.

Okay, they’re rich already because are paid a salary bigger than the GDP of the Benelux countries, but the point is, they’ll get even richer if they wait until their company’s stock goes up enough for them to make a killing on the options as well.

But as any four year-old and Hillary Clinton will tell you, waiting is hard.

So from time to time CEOs decide they are tired of waiting, particularly those who have seen their company’s stock price fall below the strike price of the options. To remedy this tragic situation, the company “reprices” the options for them. Repricing is another way of saying that the company lowers the strike price far enough for the executives to get their marshmallows back.

Stock option repricing has been going on for years. The practice the was common enough that in the early ‘90s, new proxy rules forced companies to disclose any repricing schemes. Despite the required disclosures, 40% of 113 companies surveyed by PricewaterhouseCoopers way back in 1998 had repriced options sometime over the last decade, according to CFO.com.

Although repricing has been common, it’s been about as popular with investors as the bird flu. When CFO.com did the 1998 story, it also found that proxy advisor Institutional Shareholder Services was telling clients to vote against options plans where a repricing was done without shareholder approval. ISS director Peter Gleason told the magazine that "Resetting the strike price is not pushing people to enhance the value of the firm, but rewarding them when the stock goes down, which is counter to the argument for options."

Earlier this year, Forbes reported the results of Bain & Co.'s interviews with more than 40 institutional investors here and in the U.K. Almost all of them said they opposed option repricing even though 63% were in favor of giving executives a share of the value they created for shareholders.

Companies that reprice their options can deal with annoyed shareholders easily, but FASB and the SEC pose other problems. FASB accounting rules now require companies to take a charge to earnings for options repricing. In addition, regulations now require shareholder approval to re-jigger the strike price.

So now, repricing options is not only unbecoming, it’s also expensive and tedious. Sure, companies can keep repricing despite the hassles and the costs. Or they can forget the practice and move on to other, more creative forms of compensation.

Like backdating options.

Backdating is when a company secures approval to issue a new round of options, but changes the issue date to coincide with a particularly low stock price. That way, executives secure an immediate windfall rather than having to wait, wait, wait for the stock to move above the strike price.

Even though backdating is technically legal, the pencil whipping must be disclosed. So regulators are now investigating several companies to see if they were sneaky about setting the issue date of the options.

Ironically, stock option plans became popular because investors figured that options aligned the interests of management with those of shareholders. The better the company did, the better the shareholders would do, and the richer the CEO would become. You know, all for one and one for all.

But with big salaries on the front end, big pensions on the back end, and stock option plans designed to remove the “deferred” from “deferred gratification,” today options often mean one thing:

More marshmallows for those already clutching the bag.

[USFRIENDINVICTORIA]

Set their marshmallows alight, drop them in the ashes, and then see if they still want to eat them. (I'm not sure what I'm saying here -- just stretching a metaphor until it's ready to snap.)

[ConservativeMind]

Why not just give the people a bonus in the proportionate amount of the gains that year, for a guaranteed number of years in the future?

They get no stock that way and they directly benefit from their efforts at the company. If the company's stock goes down from the prior year, the executive gets nothing that year.

[Cedar]

This is a sticky subject for many.

[kenth]

That's not fair. Those other kids who went ahead and ate their marshmallows should have sued to get their second ones. It's their right to fluff.