Stock options worries cast shadow over Silicon Valley

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Few things, with the possible exceptions of chinos and corporate-logo polo shirts, are more emblematic of Silicon Valley’s entrepreneurial culture than stock options.

So it should come as no surprise that mounting concerns about whether executives may have inappropriately enriched themselves by manipulating the timing of stock options grants have cast a shadow over the valley’s technology industry.

Several companies whose stock options granting practices have come under official scrutiny from US authorities call Silicon Valley their home. Bay Area companies whose practices are being investigated include KLA-Tencor, a chipmaker; OpenWave, a software group; and Juniper Networks, a networking equipment maker.

As the scope of of the scrutiny widens, it has begun to raise broader questions about the quality of corporate governance in the world’s premiere high-tech hotspot. “As a shareholder you would always worry about what else [management] are doing,” says Henry Hu, a professor at the University of Texas law school who studies legal questions surrounding options and other financial instruments.

Prof Hu says the rapid growth of many companies in the valley, where the pace of technological change means that no-name companies can turn into multibillion-dollar giants in a few years, may have contributed to a lax governance culture.

“When you are a company growing really fast, your systems may not grow up accordingly,” he says. “With a more mature company you have a generation or two of human capital devoted to making sure all the controls are there.”

The problem of stock options back-dating began in March, after the Wall Street Journal published a report describing several cases of unusual timing of stock options grants. The pattern suggested that some companies may have retroactively granted options on dates that coincided with low points in the value of their shares. If such actions took place without being disclosed to shareholders, it would raise serious legal and governance concerns.

Until recently, Silicon Valley had avoided the ethical scandals that plagued other industries in the wake of the dotcom bust.

Although investors lost billions as companies with questionable business plans collapsed, the tech industry emerged from the ruckus with its ethical reputation mostly intact. In spite of huge losses, and contrary to the expectations of some, the internet bubble failed to produce the tech-sector equivalent of an Enron or WorldCom.

Now, with evidence suggesting that some executives may have manipulated stock options procedures, academics and analysts say it is time for companies to pause and take stock of their internal controls. “This should cause some introspection,” says David Larcker, a professor at Stanford University’s Graduate School of Business and an expert on corporate governance.

Prof Larcker says the stock market’s reaction to the unfolding controversy is a sign of investor fear that companies may have more dirty laundry to air.

“Some of these companies saw their stock price back off 10-15 per cent,” he says. “These guys didn’t abscond with 10-15 per cent of the value of the company. The market has to be looking at that and saying there could be broader governance issues and there could be executive turnover.”

Although the award of stock options is a common practice, in Silicon Valley options take on a special significance.

Because they only have value if a company’s shares rise above a certain strike price, options have long been viewed as a preferred way to reward both executives and employees who come to work in Silicon Valley’s risky start-ups. Prof Larcker says that entrepreneurial culture, along with the need to invest cash first in new technologies, may have led some companies to under-invest in governance controls.

“Having great accounting is not going to help you make it,” he says. “You can easily run out of cash. It’s a very tough thing to hit it big. On the way these companies spend most of their time and money on technological innovation. If you don’t break the technology barrier, it’s over.”

Even before the recent revelations about suspected options back-dating, there were signs that the stock options’ heyday in the valley was over.

The coming of Sarbanes Oxley, along with new rules that went into effect this year requiring companies to take the expense of stock options into account in their company reports, means that boards of directors are no longer using options to the extent they did during the 1990s boom.

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