ISS on Option Timing

Cite this Article
Bill Sjostrom, ISS on Option Timing, Truth on the Market (July 18, 2006),

Institutional Shareholder Services (ISS) has posted an eight-page white
paper entitled An Investor Guide to the Stock Option Timing Scandal. The paper provides a good overview of the recent option backdating and spring-loading revelations.

There has been a number of posts in the blawgosphere debating the legality of backdating and spring-loading. While these practices are not necessarily illegal, as the paper points out:

The option-timing scandal . . . calls into question the oversight provided by boards and compensation committee members at these companies. . . . [I]nvestors may fear that other accounting problems exist but have yet to come to light. The disclosure of backdating sends a ‘signal that management is willing to fudge numbers for their own benefit and they might be willing to play other accounting tricks.’

ISS recommends the following as best practices for option grants:

  • Adopt “blackout” periods to preclude stock grants when company executives have material, non-public information in hand.
  • Adopt fixed grant date schedules that provide for grants on a periodic basis (monthly, quarterly, or annually), along with rules for the establishment of option exercise prices on such grant dates.
  • Refrain from making grants on these fixed dates when executives have market-moving news.
  • Disclose the rationale for grants on a certain date, explaining why the compensation committee chose that date over other possible dates.
  • File Form 4 reports on option grants promptly with the SEC.

While these practices would certainly go a long way towards eliminating backdating and spring-loading, as Geoff pointed out essentially on day one of the scandal (see here), option timing can be an efficient form of compensation. SEC Commissioner Atkins recently expressed a similar view regarding spring-loading in a speech before the International Corporate Governance Network (see here). This view, however, has not been particularly well received (see, e.g., here), perhaps in part for the reasons Tom discusses here.

It will be interesting to see how many companies adopt the measures recommended by ISS. For companies embroiled in the scandal, the lost flexibility in designing a compensation package would likely be outweighed by the potential restoration of investor confidence. For companies outside the fray, perhaps the scandal will simply result in a couple of lines of added disclosure along the lines of “The compensation committee may, in the exercise of its business judgment, from time to time approve grants of options shortly before the public disclosure of favorable company developments.”