Fast-Forward on Options
By Ben White
Monday, December 19, 2005
At least 22 Washington area companies are among hundreds
nationwide that have transformed millions of stock options,
many of which would not have been available for executives
to use until 2009, into fully vested shares.
According to Wall Street estimates, the fast-forwarding
could wipe away more than $4 billion in expenses that would
otherwise have shown up on income statements starting in
2006 under a new accounting rule that goes into effect Jan.
None of this is illegal. But some financial analysts and
corporate-governance experts say it is a dubious exercise
nonetheless because it undermines the intent of the
much-debated new rule. The critics also say that speeding up
options hands an extra treat to already-well-fed executives,
hurts a company's shareholders and misleads prospective
Many of the companies that have pushed forward options
vesting dates to beat the Dec. 31 deadline come from the
high-technology and health care sectors, industries that
have been heavy users of stock options in recent years.
Linthicum, Md.-based network specialist Ciena Corp., for
example, announced in late October that it would accelerate
the vesting dates for 14.1 million shares awarded to
employees, officers and directors. Ciena said the
accelerated vesting would help the firm erase $21.5 million
While that is just a small fraction of the $436 million the
company lost in the past year, executives nevertheless said
they thought it made little sense for the company to record
a cost based on options that are "out of the money," meaning
the current market price of the stock had fallen below the
fixed price at which the options were awarded. In such
cases, employees typically delay exercising the options
until the stock price rises. At that point, they are "in the
money" and can be resold at a profit.
"Ciena's board of directors considered the expense savings
that will occur under new accounting regulation and the lack
of employee retention value associated with out-of-the-money
options and firmly believes that accelerating these options
is in the best interest of the Company and its
shareholders," Ciena Executive Chairman Patrick H. Nettles
said in a news release.
Nonsense, say the critics.
"This is simply a tactic by companies to lower their
expenses and artificially inflate their earnings," said Bear
Stearns analyst Chris Senyek. "It's smoke and mirrors." In a
recent report, Senyek identified 439 companies that had sped
up stock-option vesting as of late last month.
Senyek said moves such as Ciena's make it harder to compare
companies because some have accelerated options vesting
while others have not. He also said it makes it tough to
gauge, at least in the short term, a company's earnings
potential, a key measure for prospective investors. That's
because while a company may recognize little or no option
expense in 2006, it could still issue new options that would
drive up expenses by an unknown amount in future years.
Paul Hodgson, senior analyst the Corporate Library, a
research firm, put it more simply. "It's lying," he said.
"It may be legitimate lying, but it is nevertheless lying to
shareholders about the cost of options."
In addition to Ciena, companies with major operations in the
Washington area that avoided the most expenses by
accelerating options include Applera Corp., parent of
Rockville biotechnology firm Celera Genomics. Applera said
it wiped away $108.1 million in potential expenses over the
next three fiscal years -- a significant savings for a
company whose two units reported combined profit of about
$40 million in the quarter ended Sept. 30.
McLean-based newspaper publisher Gannett Co., parent of USA
Today, said it avoided $52 million in future expenses by
accelerating options -- equivalent to about one-sixth of its
earnings for the third quarter.
But it is hard to know if these are in fact the biggest
Some companies disclosed the total number of options
accelerated but did not attach a value to them. For example,
McLean consulting firm BearingPoint Inc., which has been
struggling with accounting problems, last week said it would
accelerate the vesting of 3.2 million shares, or about 23
percent of the company's outstanding unvested options. The
firm did not say how much it expected to save in potential
future options expense.
BearingPoint said most of the accelerated shares would have
vested in 2006 and 2007. Some companies have not disclosed
when accelerated options would normally have vested. Among
those that have, many said they accelerated option vesting
periods by one to four years.
Disclosure is spotty in other areas, as well. For example,
Chantilly-based GTSI Corp., which sells technology services
and products to the federal government, said on Nov. 21 that
it would accelerate the vesting of 75,000 options held by
chief executive M. Dendy Young and 57,500 options held by
Chief Financial Officer Thomas A. Mutyrn. But many other
firms have not disclosed the names of executives receiving
accelerated options. That information is expected to appear
in executive compensation disclosure forms next year.
Stock options give the holder the right to buy a company's
stock at a set price within a specific period of time.
Typically, option grants "vest," or become available for the
holder to use, in individual blocks over a period of several
years. The original idea behind options was to give top
employees a reason to stay and work hard over the long term
to make a company successful and boost its stock price. The
higher the stock, the more valuable the options.
Stock options have been a hot compensation tool for years,
especially among fledgling companies with limited cash but
with prospects for rapid growth. Until now, companies did
not have to count options as an expense in their income
statements. Instead, they could simply include an estimate
for options value in a footnote in their financial
But after a wrenching 10-year debate, the Financial
Accounting Standards Board late last year approved a new
rule requiring that companies deduct an amount from their
earnings that reflects the estimated value of stock options.
Adoption of the new rule came over the objections of
corporate lobbyists, especially from the technology
industry, and was a major victory for shareholders' rights
The shareholder groups had argued for years that options
represent a real cost to a company and its investors. When
employees exercise options, the number of a company's
outstanding shares rises, making all existing shares less
valuable. In addition, the shares could have been sold to
the public and the money added to the firm's capital,
instead of being awarded to executives.
Many companies responded to those arguments by saying that
any move to require options expensing would badly dent
earnings and that no reliable model existed to value
The Financial Accounting Standards Board last year rejected
those arguments, at least in part because of investor
outrage over recent corporate scandals, many of which
occurred at companies that were heavy stock-option users.
The SEC earlier this year said companies could use one of
several approved methods to value their options.
Several big companies, including Microsoft Corp., decided to
record the cost of options in advance of the new rule. But
for many others, the new regime will begin Jan. 1, leaving
corporate executives and directors looking for a way to
avoid the earnings hit.
Executives at several companies that accelerated options
vesting said they knew they would be criticized but decided
to proceed anyway rather than see earnings suffer. Many said
they accelerated options because their competitors had
already done so. Others said they feared that competitors
would accelerate options before year-end.
"If we had a half-a-million-dollar compensation hit, that
would really lower our earnings. And how would we have been
perceived against people who didn't have that expense?" said
Steven R. Delmar, chief financial officer at Gaithersburg
network management software maker Ace-Comm Corp. "We
probably spent a good six months, between myself, legal
counsel, accounting and the board, sort of researching and
analyzing this and taking a look at what other companies
were going to do. . . . It was not an easy decision. And I'm
not sure there is one right, easy decision on this."
Richard I. Linhart, chief operating officer of James Monroe
Bancorp Inc., said regulators essentially changed the rules
in the middle of the game. He said that if companies had
been operating under the new accounting rule when they
awarded options, they might never have handed them out.
"It's a little hard to point the finger," he said. Options
awards "were made based on the accounting rules that existed
at the time."
But by far the most popular argument among executives is
that they accelerated only out-of-the money options. Michael
P. Donovan, chief financial officer of Rockville pharmacy
benefit management firm HealthExtras Inc., said the company
decided not to accelerate the vesting of options that were
significantly "in the money," or below the company's current
"Where there was a golden handcuff value, we kept it there,"
Donovan said of the firm's approach, using a common term for
Shareholder advocate Nell Minow, co-founder of the Corporate
Library, dismissed that rationale, saying out-of-the-money
options (also known as underwater options) should still be
considered an expense. "You might hear people say that
underwater options aren't worth anything, but ask them to
give them to you and see if they agree," she said.
Other firms, including BearingPoint, noted in SEC filings
that they were accelerating options vesting for only
rank-and-file employees, not for senior executives and
directors. "We didn't think it was right for the people who
were making this decision to benefit from it," said
BearingPoint spokesman John Schneidawind.
Senyek of Bear Stearns said his list has become a hot item
among corporate executives who want to see if their
competitors are on it. He said he expects many more firms to
hit the fast-forward button before the new year dawns.
"Everyone wants to jump on the bandwagon," he said.