How stock options rob shareholders

By Michael Brush

Employees have reaped billions of dollars in profits at shareholders' expense over the past decade thanks to the excessive use of stock options at leading technology companies.

At Cisco Systems (CSCO, news, msgs), executives and other employees pocketed gains of $24 billion over 12 years, and the company spent $19 billion buying back shares to offset the impact of options compensation. At Broadcom (BRCM, news, msgs), which has suffered nearly $6 billion in operating losses over the past 12 years, insiders collected $5 billion in options profits over the same period.

"Stock options are just legitimized theft," says Albert Meyer, an accounting expert who manages money for Bastiat Capital in Plano, Texas. Meyer, who has studied options grants, estimates that hundreds of companies have abused their shareholders with excessive issuance of options.

If these companies hadn't abused options-based pay, the money could have been returned to shareholders in the form of dividends or reinvested to build the companies' operations.

Meyer examined the options-pay practices at the largest constituents of the Nasdaq 100, an index stocked with large technology companies. Even in that small sample, he estimates, there are at least 30 other companies that have issued enough options to seriously affect the companies' financial results.

Among them: Dell (DELL, news, msgs), which between 1995 to 2005 spent more than $16 billion buying back stock to help offset its options outlays.

Stock options have come under fire recently, specifically because some companies, apparently, backdated options to make it even easier for executives to engineer fat paychecks.

The size of options awards has drawn fire, too. Corporate executives have paid themselves with batches of options so large that their compensation sometimes has swelled into the hundreds of millions of dollars. But many of those pay packages have paled in comparison to corporate profits. Former ExxonMobil (XOM, news, msgs) CEO Lee Raymond took home $70 million in 2005. But Exxon generated $36 billion in net income that year. It seemed CEOs were simply being rewarded for their work on behalf of shareholders.

Meyer's work, though, shows just how big a piece of the profit pie was being served up to some companies' insiders. "The equity owners, the people who own the business, are just having a lot of their equity given away," says Don Hodges, the president of the Hodges Fund (HDPMX) and a critic of corporate compensation plans.

Wiping out 12 years of profits

A quick primer on stock options: Companies issue options to employees with so-called strike prices and vesting periods. An employee is essentially given the right to buy shares at the strike price at some future date. If the employee gets 100 shares with a $5 strike price and the stock has risen to $10 by the vesting period, the employee can buy at the lower price and reap a quick profit.

The idea is to align employees' interests with those of shareholders to encourage productivity and profits. But the excessive use of options has created a means for companies to funnel profits directly to employees -- mostly top executives -- at the expense of shareholders.

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