Monday, October 12, 2009

Trouble with stock options, part deux

We've heard plenty about the option backdating scandal in which firms retroactively awarded stock options at the lowest stock price of the quarter.

Well now there appears to be a new, but related scandal brewing. The WSJ discusses a new study by Fich, Cai and Tran at Drexel U. who find that firms that are in merger negotiations are pretty liberal with their option grants.

They allege that when negotiations about a merger are being quietly made, the target firm grants options to the CEO of the target. Then, when the merger is announced the stock price will most likely go up and the CEO makes out.

One possible explanation is that you want to incent the CEO to get the best possible price from the merger, and options will do that. But as is pointed out in the article, the CEO's pay package should already provide the correct incentives if it is well constructed.