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The Employee Ownership Update

Corey Rosen

December 12, 2002

(Corey Rosen)

United Declares Bankruptcy; Trustees Sell ESOP and 401(k) Shares

United's bankruptcy won't have quite the impact on the company's ESOP and 401(k) plans that might be expected. That's because trustees of both plans have been selling off shares held by employees in both plans. The ESOP sell-off started in October with about 20% of the shares sold before the bankruptcy announcement. The remaining shares in the two plans will be sold in coming weeks, assuming there are buyers. The price obviously will be minimal, but, in bankruptcy, the employee shareholders would likely get nothing for the shares. Employees may still ask for equity in exchange for the inevitably large concessions they will be required to make. In the contract talks prior to bankruptcy, the pilots and flight attendants had already agreed to get options for concessions. The creditors' committee and bankruptcy courts, however, will now have the final say on the issue. (Note: As of today, a court has issued a temporary injuction that could prevent further sales of the ESOP-held stock.)

The press reaction to the bankruptcy has been more positive for ESOPs than many had feared. Syndicated articles in The Chicago Tribune, LA Times (by columnist Jim Flanagan), and the AP newswire all highlighted the benefits ESOPs can provide, as well as some of the pitfalls when poorly run. Stories in The Wall Street Journal, Washington Post, San Francisco Chronicle, CBS Market Watch, NPR, and other media also looked at what makes ESOPs work. The NCEO played an active role in the talking to the media, pointing to research on the critical relationship between creating an ownership culture and ESOP success. All the stories pointed to the lack of that connection at United as a key problem.

SEC to Change Rule on Voting on Stock Options Expensing

In a December 6 letter to the United Brotherhood of Carpenters and Joiners, Martin Dunn, the SEC's deputy director of corporation finance, said that following an SEC review of the matter, "in the future, we will not treat shareholder proposals requesting the expensing of stock options as relating to ordinary business matters." The SEC had already been going in this direction in two prior letters on this matter, but this new letter makes it clear that this will be SEC policy generally, not just on a case-by-case basis. Prior to these letters, companies could exclude proxies asking for expensing saying that they related to ordinary business issues not within the scope of proxy requirements.

Would Stock Option Expensing Really Matter?

In a new study of the market's reaction to announcements that companies were going to expense options, Towers Perrin has found that in the 120 days surrounding the announcement by 103 companies in the summer of 2002 that they were going to expense options, stock prices at these companies did not go up or down more than would have been expected based on normalized comparative results for the market in general. "Markets are very good at reflecting available information in security prices and were already awash in information about option grants and their economic costs," said Scott Olsen, co-leader of Towers Perrin's Executive Compensation consulting practice. "The study notes that in similar past situations, stock markets have ignored accounting and have paid attention to economics when examining company accounting choices in areas like inventory, depreciation or business combinations." (Source: Announcement of Option Expensing Has No Impact on Share Price, Towers Perrin Study Finds, Nov. 21, 2003, ).

In Expensing Employee Stock Options: Lifting the Fog by Norbert Michel and Paul Garwood of the Center for Data Analysis of the Heritage Foundation (report 02-06, October 18, 2002), the authors conclude that the stock market would react with indifference to expensing stock options. The conclusion is based on a study of the market's reaction to six events from 1993 through 1995 surrounding the announcement by the FASB that it would consider requiring stock options expensing and, eventually, its announcement that it would only require expensing to appear in footnotes. The authors used a common technique in stock market research called an "event study." Event studies focus on the market's immediate reactions over one or two days to a particular announcement. The authors hypothesized that if the market "cared" about expensing, prices for companies with the highest percentage of overhang would decline relative to those with the lowest. So when announcements were made suggesting expensing would be required, the prices of companies with a lot of overhang should have gone down, and they should have gone up when the news suggested expensing might not have been required. In fact, the authors found no evidence that this happened. Instead, the market appeared indifferent to the announcements.

This conclusion, to be sure, is based on an indirect measurement , but it is intriguing that the market seems to see the additional information expensing provides (compared to what then already existed, namely the dilution form outstanding options) as at least not very compelling. It also appears to be the only empirical analysis of this issue to date. The study is available at the Heritage Foundation's Web site.

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