12 February 2007

Evil Jobs screwed Pixar Shareholders

Going the rounds are the latest in the options backdating scandal. Now, Steve Jobs is accused of choosing fortuitous dates for the granting of options to some key employees at Pixar Studios (FT subscription required, but story available elsewhere)

I am very much against bosses getting rich at the expense of shareholders, and I am also (obviously) against fraudulent behaviour in the corporate world.

But the options backdating issue has gone too far and its impact is now becoming severely detrimental to businesses (and their shareholders) caught up in it. First of all, most of the stories I have seen go back sometime. A time when options were not expensed, and they were considered a key part of an employee's package. There have been changes in thinking given all sorts of corporate scandals, and that is to be welcomed. But it is neither right (unless fraud was involved) or worthwhile to be revisiting today's thinking on the past.

Employee options have been part of Silicon Valley for a longtime. As a motivation factor, most bosses wish to issue those to employees at an attractive price (in-the-money, rather than under-water) for fairly obvious reasons. It takes a huge amount of time to process an options scheme and issuance from planning to getting board approval for the scheme and to deciding who gets what and writing the detail agreements. During that time, many circumstances will change. For the most part it makes sense to choose a date that serves the (motivational) purpose, and I would argue that as long as that date is chosen between the start and end of these processes, it is quite reasonable. It would NOT be reasonable if the effect was material, and/or if fraud was involved. It would also not be reasonable if management had conspired to artificially reduce the stock price for a short period (or issued them below any recorded stock price). For issuing options to senior management, it is also obvious that board approval is a part of that process. Jobs should not have been able to issue options to himself for instance (or his senior fellow executives) without that board approval. It is the board, not the management, that is ultimately responsible to shareholders. In the case of Apple, it is not yet clear what transpired as we have only Apple's (admittedly external and supposedly independent) report to judge by. I am not judging Apple and Jobs behaviour at Apple in this post. I don't know enough to do that and I suspect most of you reading this don't either.

Just before we look at Pixar, let's consider who the victims are of options backdating. If someone gets options at an "unfair" price, the people who lose out are the shareholders. They lose out because to make good on the options for the employee the company has to buy them in at the market rate (or issue more shares thus diluting existing shareholders). Only shareholders lose out - no one else, and usually only by small amounts. I have advised a number of companies with share option schemes. In all those cases, it has taken a period of several months or longer to get them issued, and I have advised choosing as low a price as possible for those options (in the UK, the tax authorities have to approve a price anyhow - another action that takes time). Scandal? No. These are private companies and the shareholders are the very same people making the decision on issuing options to those employees. In some cases, I too have been a shareholder of that company. We have chosen the price to serve as motivation, which is the prime purpose of the scheme in the first place. As shareholders, we want our staff to be motivated, and are prepared to carry that expense personally.

So, onto Pixar. Pixar is different from Hob's examples above isn't it? It was a public company (prior to being bought by Disney). But, and this is where it is interesting, who owned the largest number of shares in Pixar?

Steve Jobs did, of course. Not just by a small margin. He owned MORE THAN HALF the company, in fact, and, in that position has plenty of rights anyway.

So, who was the biggest "victim" of Steve's generosity with John Lasseter? Steve himself - by a massive factor. He wanted those staff to be motivated, and indeed it served both him and the other shareholders well. When Disney bought Pixar, a large part of the (huge) value it paid was for the people that came with it. If Steve had feathered his own nest at Pixar by issuing options to himself (whether at favourable rates or not) then that would be an issue. But Jobs (to my knowledge) was not a recipient of any options at Pixar. Steve was just doing his job, and probably thought nothing of it. In doing his job, he certainly helped John Lasseter, but if there's a Pixar shareholder out there that thinks Steve didn't do well for them, I'd be amazed.

Oh, and one more thing. Any retribution that is made here almost certainly is a case of Peter robbing Paul. If shareholders were the ones that suffered, then taking money from shareholders funds to recompense almost certainly makes no sense. While there are some worrying examples, it seems to me that the biggest beneficiaries of the options backdating scandal are in fact the lawyers and accountants drafted in to sort this out, and the careers of federal and state prosecutors.

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Unknown said...

It would NOT be reasonable if the effect was material, and/or if fraud was involved.

The effect is material - the stock that's granted could otherwise have been sold on the open market. So there's a loss that way if the option is artificially underpriced.

As to Jobs being the biggest shareholder - big deal. All shareholders are equal; all deserve fair treatment. If Pixar was public then all shareholders are affected if the options were wrongly offered, for the reason just given.

Ian Hobson said...

First of all, I do not believe the effect of this IS material. Pixar was sold for a price in the billions, and this is for an amount more like 0.1% of that figure.

Second, it is not illegal to backdate options or to choose a particular price. I have given reasons in my post why this is done and why shareholders will generally support such things. They exercise their votes on electing representatives each year to do those things on their behalf.

The issue is whether it is done according to the law (and the law in place at the time).

I am pointing out that this seems to have gone too far. There are examples of serious materiality, but this is not one of them (and nor is the Apple case material, though I can't comment on the legality).

I'm sure Jobs understood in big terms the contract he was offering John Lasseter and believed it was in the interests of the company, of which he was not just the biggest but also a majority shareholder. His judgement appears to have been right in terms of the eventual big-picture outcome.

There is a witch-hunt here that is focusing on whether i's were dotted and t's were crossed. It is about lawyers careers and lawyers pockets. It is not in general about shareholders interests.

If you disagree here, please tell me the quantum of the issue and how shareholders would in reality have benefitted or will benefit from any action now taken by these lawyers?

Anonymous said...

Regards to the topic, I got a pesentation topic "Do you consider the granting of share options to senior management is in the interests of shareholders?". Would you mind sharing some of your views ?

Ian Hobson said...

In answer to "Do you consider the granting of share options to senior management is in the interests of shareholders?".

It is an absolute yes. I can think of no better way to align management to shareholders interests than have both share in the same rewards either via dividend and/or capital return.

I'd go one step further. I believe that ALL staff should participate in this scheme, and in the companies I have been involved with, I'm pleased that such a situation has existed.

I do not believe in golden hellos and golden goodbyes, which stink. I also think that schemes need to be changed such that management should have to hang on to their shares for longer periods - including after they have left - to discourage short term stock price inflation/fraud and align towards long term capital growth.

But I do think it is reasonable to give shares at a small discount to staff for encouragement, and this, of course is how many employee share option schemes are run. I believe this is better for shareholders than the expenses incurred in either the golden hello or golden parachute payments.

I hope that's clear enough.