Researching Stock options when Investing in Stock

Stock Option Grants

In your investment research do you focus on the frequency, timing and quantum of grants of options to Directors and Officers?

If you don’t, you should. The Canadian Securities Regulatory Climate
enables Boards of Directors to grant common stock options based on
shareholder approval. Current convention dictates that at any given
time shareholders generally approve option grants equal to up to 10% of
the then outstanding common shares, although such approvals can result
in lower or higher aggregate option grant percentages. For a variety of
reasons, including TSX Rules and Canadian Income Tax Regulation, stock
options typically are priced at ‘fair market value’ at the date of
grant. For this purpose ‘fair market value’ usually is taken to be the
most recent share closing price.

Often options of comparatively large numbers of shares are granted
to company executives on the premise that those executives are paid
less than commercial salaries, and the options in part compensate for
that. Options also sometimes are granted to Directors in lieu of, or
partial compensation for, Director’s fees. We believe:

• where option grants are argued to be in lieu of commercial
compensation such thinking introduces a level of ‘compensation
subjectivity’ that should not exist;

• executives should be properly and fairly compensated by cash
payments (annual salaries and cash bonuses) for their day-to-day
involvement in running a company;

• options granted to executives should be structured so as to only
reward them for extraordinary company performance as defined by the
Board of Directors and as indirectly approved by the shareholders
pursuant to them being willing investors in the company; and,

• granting options to Directors in comparatively small and
non-egregious quantities generally is sensible given the ever
increasing fiduciary responsibilities assumed by Directors.

We are particularly sensitive to the frequency and timing of option
grants and the number of options granted. For example, we find it
offensive when shortly after a company completes a successful Private
Placement of common shares the Board of Directors grants incremental
options to ‘top up’ previously outstanding options – particularly where
it is not clearly stated in the Private Placement documents that such
option grants are planned. As investors we always dislike what we
perceive to be ‘granting of excessive options’. We simply refuse to
invest in companies where we analytically and intuitively think this is
the case. We suggest you consider these things in your own analysis.

The views expressed in this Post are those of the author. They
are offered to readers for information and general guidance only. They
are neither intended to, nor should be taken to, constitute economic or
investment advice. See Legal Disclaimer.