Stock Options Not Limited to Executives
Study Finds Board Members Profit, Too
Terence O'Hara, Staff Writer
Monday, December 18, 2006
Chief executives weren't the only ones enjoying
near-guaranteed profits from stock options in the past
decade. Outside directors at hundreds of American companies
also received option grants that are likely to have been
manipulated, a new study found.
According to the study, 9 percent of 29,000 option grants to
outside directors from 1996 to 2005 were granted on a day
when the company stock price was at a monthly low. The
likelihood of such a concentration of "lucky" grants is so
low as to be statistically impossible, the study's authors
"It's like going to Vegas thousands of times and betting on
red every time and winning more than half the time," said
Lucian Bebchuk, the Harvard University professor who
co-authored the report, titled "Lucky Directors," with
Cornell University's Yaniv Grinstein and Urs Peyer, a
professor at the French business school Insead. "From a
numerical standpoint, it can't be random. There has to be
some manipulation of the outcome."
The study found the "lucky grants" at about 460 firms,
involving about 1,400 outside directors.
Outside directors are board members who aren't management,
and they are the shareholders' chief representatives,
responsible for overseeing management and making sure
executives don't profit unnecessarily at shareholder
expense. The Securities and Exchange Commission, following
similar studies in recent years that focused on executive
stock option grants, has been investigating options
More than 130 such companies have disclosed probes of their
options-granting practices, and a handful of chief
executives have lost their jobs because of backdating.
Options give the holder the right to buy company stock at a
preset price, usually on the date the option is awarded.
When options are awarded to executives, they allow
executives to profit from the rise in the stock price.
But when an option is priced at a date in the past when the
price was low, it essentially guarantees a profit, thus
negating the rationale for options.
Until this study, however, no one had focused on option
grants to directors.
Bebchuk said the lack of attention was because the vast
majority of options awarded to directors fall on the date of
the annual meeting and are typically much smaller than
"In the data, we found that directors' grants are equally
susceptible to manipulation," Bebchuk said.
A lucky director grant was more likely at companies where
executives received lucky grants, the study found. And
firms with a higher incidence of lucky option grants were
more likely to have governance practices considered
unfriendly to shareholders, such as a minority of
independent directors on the board.
The firms were also more likely to have "entrenching"
bylaws, which make it difficult for shareholders to remove
The study is not the first to raise questions about a
possible link between options backdating practices and board
governance practices. A study by the Corporate Library of
120 companies implicated in backdating found a high
incidence of interlocking directors, or directors who served
on more than one company that backdated.
The study suggested that backdating practices may have
spread from company to company through these interlocking