Let's Stand Up to Scandalous Stock Options

By
Tim Hanson


July 22, 2009

"So now that the stock price has doubled, are you going to reprice your options back up?"

That question silenced Home Inns (Nasdaq: HMIN) investor relations manager Ethan Ruan when we met with him at the company's headquarters in Shanghai, during our recent Motley Fool Global Gains
research trip to China. He'd just finished telling us how excited
management was that they'd gotten such a good strike price ($7.26 per
ADR) on the stock options they canceled, then repriced and re-issued.

Newsflash, Mr. Ruan: Potential investors don't like hearing how
excited management is about their latest move to bilk outside
shareholders.

And your explanation was a stupid one
Asked
why the company felt it necessary to re-price all of the unvested,
out-of-the-money options it had granted to senior management, Mr. Ruan
responded that the company worried that having options with such high
strike prices -- Home Inns' stock dropped 85% in the year preceding the
October 2008 option reissuance -- would demotivate employees and
possibly cause retention issues.

This is a tough pill to
swallow. The company's founders and senior officers already owned
hundreds of thousands of options with a strike price of $11 per ADR or
less. Furthermore, those company directors and executive officers (as
of the last 20-F filing) already owned 15% of the stock. I find it hard
to believe these key folks were going anywhere.

In addition, it's not like the stock market unfairly turned on this
company, costing executives compensation to which they were rightly
entitled. The team here took many steps that destroyed value, including
the ill-conceived and -executed acquisition of unprofitable rival
Chinese hotel chain Top Star, an inability to control rising expenses,
and the launch of a new concept -- the H Hotel -- that the company,
according to Mr. Ruan, has no intention of growing.

These efforts have consumed capital at an alarming rate. The company recently had to sell an additional 7.5 million shares to Ctrip.com (Nasdaq: CTRP)
to raise a needed $50 million. (Incidentally, Ctrip.com was founded,
and remains largely owned, by some of the same folks who founded and
own Home Inns.)

So stay away from Home Inns
Of
course, while Home Inns is a particularly egregious example of the
inanity of options repricing -- not to mention the company that gave us
the most stupefying quotes of our trip -- it is far from the only
culprit. In fact, thanks to the significant stock market decline of the
past 24 months, companies around the world are looking at how, and by
how much, they can reprice existing stock option compensation packages.

For instance, eBay (Nasdaq: EBAY) shareholders recently approved a plan to reprice employee options. Google (Nasdaq: GOOG), Williams Sonoma (NYSE: WSM), NVIDIA (Nasdaq: NVDA), and MGM Mirage (NYSE: MGM) are among the companies that have completed or proposed some form of repricing to improve morale and sustain retention.

To be fair, some companies -- though not all of them -- have
excluded top management from eligibility here. But even so, there isn't
a surplus of high-paying jobs out there today. How many employees,
faced with worthless stock options, will really pack up and move on?

The fact of the matter is …
Shareholders
should be outraged at the suggestion that stock options should be
repriced in the wake of this financial collapse. After all, those
options were intended to align employee and shareholder interests, and
specifically designed not to be a guaranteed form of
compensation. Since shareholders can't reprice what they paid to buy a
stock, repriced stock options subvert even the illusion of alignment.

Furthermore,
repriced options hurt outside shareholders by diluting their ownership
stake and therefore their claim on earnings. This makes every
individual share worth less over the long run.

The bigger picture
Option
repricing is just one more example of a situation where people who were
happy to reap enormous profits when things were going well are now
unwilling to accept the consequences after things have turned south.
Sound familiar? This is precisely the culture that drove the folks at
places like Fannie Mae and AIG to
take undue levels of risk, because they figured they'd be bailed out if
they failed. And the bailouts came -- while executives have largely
kept the profits they piled up en route to our current housing collapse.

This is absurd. If you can't handle the downside, don't accept variable compensation.

Stand up to scandalous stock options
A
number of us here at the Fool are actually surprised that in our
litigious society, there hasn't been some form of shareholder-driven
class-action lawsuit brought against companies that reprice options,
perhaps based on the fact that doing so means that these companies'
financial statements have underreported their actual cost of
employment. Google, for example, which

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