Repricing Isn’t Right

The essential problem with the hefty salaries and stock-option grants (that top executives now take to be their god-given right) is that the people handing out the salaries and the options are effectively the same people who are receiving them. In cases where the CEO is also chairman of the board, that’s almost literally true, but even in cases where the board is made up of outside directors, those directors are often CEOs or top managers at other companies, who presumably will benefit if executive salaries rise in general.

Ideally, of course, shareholders would step in to hold down egregious salary increases. But shareholders are prohibited from determining the salary of a given individual, and although some resolutions have been offered restricting a company’s top salary to the multiple of the average employee’s pay (so the CEO could only make 20 times what the average worker makes), they’ve rarely garnered more than 5 percent of shareholder votes. At a time when the market is booming, the scratch-my-back-and-I’ll-scratch-yours strategy seems to be working quite well for top execs.

All of this makes what happened last Thursday at General Datacomm Industries’ annual meeting especially important, as shareholders voted in a resolution blocking the company from repricing stock options without prior shareholder approval.

Repricing options is, of course, a viscerally repulsive practice. Corporations that have seen their stock prices tumble change the strike price of their employees’ options so that if the stock rises from the point to which it’s fallen everyone can get rich. Everyone, that is, but the shareholders who bought the stock when it was much higher. Options are traditionally justified as a necessary incentive designed to align the interests of management and shareholders. But repricing, by essentially eliminating the downside risk for management (if the stock goes south, executives know they’ll get another chance at a fortune), destroys the very alignment options were supposed to create.

The picture is, to be sure, more complicated than this. If we don’t reprice, companies argue, we’ll have a hard time holding on to our employees. And it’s also true that repricing options only for employees below a certain level makes considerably more sense than repricing for senior management. But there’s clearly a chicken-and-egg problem here. Companies say they have to reprice because otherwise they’ll lose talent. But if no one repriced, then executives wouldn’t expect that second chance. And in any case, the “talent” that companies are afraid of losing is the talent that’s responsible for the collapse of the stock. So why should companies be so anxious to keep these executives around?

There are a number of companies that already have bylaws requiring shareholder approval before repricing. But the General Datacomm vote was the first time that shareholders had added such a bylaw. (Typically, the company told the Wall Street Journal that it had “serious questions” about the resolution’s validity. In other words, company’s management doesn’t think the company’s owners should have any say over the dilution of their own stakes in the company.) In the future, repricing should become a new locus of shareholder activism. Over the past 10 years, we’ve heard so many executives take credit for all the “shareholder value” they’ve created. But when shareholder value is destroyed, it’s always someone or something else’s fault. The General Datacomm vote sends a simple message, one that should be sent to every CEO in America: if you screw up, you don’t get paid extra.