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The Employee Ownership Update

Corey Rosen

June 15, 2006

(Corey Rosen)

Options Grant Practices Scandal Grows

Dozens of companies are being scrutinized for improper grants of stock options. While the primary focus has been on backdated options, new reports are looking at companies that grant options just before releasing favorable news (now being called "spring-loading"), a potential violation of insider trading rules. Pension funds in the U.S., Europe, and Australia have initiated lawsuits against at least 34 companies, and other shareholder suits are sure to follow. Most, but not all, of the companies are technology firms.

Erik Lie and Randall Norton, the academics who first discovered the pattern of backdating, now report that 13% of the companies required to report options grants under Sarbanes-Oxley are late in their filings, and that those late filers have a distinctly better share price performance in the 30 days following their grants, a pattern that is extremely unlikely to have occurred by chance. So there could be many more companies added to the investigations list soon. Lie told the Wall Street Journal, in fact, that the list of companies who may have backdated options could grow to 10% of all companies with plans.

Christopher Cox, chairman of the Securities and Exchange Commission, has said that he may press for stronger disclosure rules in light of the scandal. Charles Grassley, chairman of the Senate Finance Committee, has asked the Justice Department if new laws are need to prosecute companies engaged in the practice, and the Public Company Accounting Oversight Board has said it will be looking at new audit guideline proposals to help deal with the issue.

Background on backdating can be found in my May 26 column.

Pension Reform Bill Still in Conference

Despite repeated promises that an agreement would soon be reached, the conference committee considering pension reform has still been unable to find common ground. House Majority Leader John Boehner now is promising a report by the end of June, although that still leaves no guaranty the bill will pass or the President will sign it (he has threatened a veto, although that would be his first). While the bill's main focus is defined benefit plans, it has considerable interest to the employee ownership community as well. Among other things, it would shorten vesting schedules on ERISA plans from the current maximum five-year cliff or seven-year graded schedules to three years and six years, make permanent the increased contribution limits passed in 2001 (and set to expire in 2010), and provide for required diversification of employer stock in public company 401(k) plans or KSOPs. Some observers now say there is a chance the bill will not be passed this Congress.

FASB Issues New Guidance on Modification of Equity Awards

On June 8, the staff of the Financial Accounting Standards Board (FASB) issued clarifications on the accounting treatment of the modification of an equity instrument in conjunction with a financial restructuring. At issue is what happens to an equity award if it is changed after the employee to whom it was granted ceases to be an employee. In August 2005, FASB ruled that if there are modifications, they would be subject to the rules under FAS 123(R). In this new staff position (FAS 123(R)-e), the staff said that if the modification is in conjunction with a financial restructuring and (1) does not result in a change in the value of the award to the recipient (such as a stock split) and (2) applies equally to all holders of that class of equity, then no modification will be considered to have taken place.

Groundbreaking Study Work in America Revisited; Authors Urge Employee Involvement and Ownership

Back in 1973, James O'Toole and Edward Lawler (a recent NCEO/Beyster Institute keynote speaker) wrote the groundbreaking study Work in America. Among other things, the study urged the expansion of the then-nascent trend towards employee involvement programs. That book largely defined the way people talked about business for many years. Now the authors have revisited the study in The New American Workplace (Palgrave-McMillan, 2006). They report a considerable expansion of employee involvement programs. "We have seen that the redesign of work is feasible, that a careful alteration of jobs can lead to participation in responsibility and profits, and that the precise nature and extent of participation is a matter for experimentation within each workplace," they told Fast Company magazine (June 2006). But the growth has not been nearly as great as its economic merits would suggest it should be.

"We were naive," they write. "We failed to recognize that the greatest obstacles to high-involvement workplaces are the attitudes and assumptions of top executives. Many are still threatened by the prospect of worker participation. And too many leaders of American corporations still believe they have 'no choice' but to match the working conditions and employment practices of their lowest-wage competitors at home and, increasingly, abroad.

"They are wrong. In 2006, the most promising fact we are able to document is the existence of high-involvement, high-wage, high-profit companies in almost every industry--for example, Southwest Airlines, Nucor Corp., W.L. Gore & Associates, Xilinx Inc., Harley-Davidson Inc., UPS, Costco Wholesale Corp., and Alcoa Inc., to cite just a few. These are productive and growing companies that have lower labor costs overall than their low-wage competitors. Because these companies involve their workers in decision making, reward them fairly for their efforts, and provide them with good training and career opportunities, their employees reciprocate the favor in terms of much higher productivity than workers in comparable low-wage companies. As executives at Starbucks explain, they are able to offer unusually high benefits to their employees not because they charge a premium for their product, but because their productive, customer-sensitive employees allow the company to realize a premium for the products and services they offer.

"The bottom line: All the evidence shows that workers who participate in decision making, training, profit sharing, and stock ownership are so much more productive than workers who don't enjoy these working conditions that they pay for their own higher salaries and benefits. They also work to keep jobs in America."

Author biography and other columns in this series

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