Paul O’Neil, Secretary of the Treasury, on a recent episode of “Meet the Press,” shared his viewpoint on the collapse of Enron. According to O’Neil, Enron’s collapse is a prime example of “the genius of capitalism.” O’Neil maintains when management’s decisions are correct, a company reaps the benefits of that correct decision. When management’s decisions are incorrect, the company pays for that, and in Enron’s case with bankruptcy.
That’s not really the way it happens. First, management insulates themselves from risk, then they engage in risky behavior in order to reap the upside. O’Neil, in his genius of capitalism description, makes it sound as if there is a downside to poor decisions. For management, it is more like a lack of upside. You can take Enron as an example, or Tucker, or just about any publicly-traded company in America.
Management typically negotiates a severance agreement that pays some multiple of their annual salary if the company is taken over or if they are fired. (In Kenneth Lay’s case $21 million times the number of years left on his contract.) They make sure the agreement has no nexus with corporate performance. Downside is protected.
Management then receives option grants that become valuable if the stock rises. There are many reasons the stock could rise. It could rise because the market is rising. It could rise because the market bids up the stock prices of the industry in which it operates. It could rise because management is doing a good job. According to the theory, options link management performance with pay. Not exactly. Options link pay with the stock price, and the stock price does not always move due to unique actions by management. If the goal were to really link performance with pay, an option program could easily be devised that links pay with relative performance. How well did the company do against the overall market? How well did the company do against similar companies in the industry?
If the stock goes down management has a couple of options for their options. They can re-price them. Ask Jerry Sanders at Advanced Micro Devices how this works, he’s done it more than once. A re-priced options means the price at which the holder can buy the stock is lowered to reflect a lower stock price. The second option is to grant more options. Since options are granted at the current stock price, granting more options allows management to participate in the upside, but with a lower starting point. Also, management decides when to grant options.
Granting more options on the day the stock is down is possible. Before Paul O’Neil poo-poos this suggestion, I found it curious that in 1995, 1996, 1997,1998 and 1999 the largest number of options O’Neil was granted in each year was at the lowest stock price. For instance, in 1999 O’Neil was granted options for 1.9 million shares of Alcoa: 1.3 million between the strike prices of $42 to $45 per share and 0.6 million at the strike price of $64.
Options are not risky, the encourage risk. There is no downside, holders are not required to buy shares. Options have an asymmetric profile. If the stock goes up, the options are valuable, if they go down, the holder has not lost anything. Severance agreements, retention bonuses, life-time pensions and medical care further protect management when it has failed.
Taking risks under this framework is easy.
“My Dad Went to the World Trade Center Kamikaze Mission and All I Got Was This Stupid Mask.”
A big cloud of soot is moving towards us. Ash is falling. A man appears with a box of bottled water. Is he selling these? No, giving them away. I grab one and give it to a couple of women huddling under a blanket? shirt? skirt? Another man arrives with another box of bottled water. I grab another bottle. Everyone looks like they have water so I use it to spit some of the soot from my mouth. I rinse my eyes. I walk down to the water’s edge with the English guy and the guy who parked his car at the Path.
People are using Kleenex, paper towels, clothing, I used my tie, to cover mouths from the soot. Some people have masks provided by their buildings. Idea for a mask, “My dad went to the World Trade Center Kamikaze mission and all I got was this stupid mask.”
Some of the people walking past me are covered in the soot/ash from the collapsed buildings. These people have a much heavier accumulation than I do. Some have what looks like mud on their faces/clothes.
Nothing new. Penatagon on fire. White House on fire? English guy says he hasn’t heard that. English guy’s cell phone (VoiceStream) is actually working. I am unable to get a circuit (AT&T Wireless), although I have five messages waiting. A woman next to English guy asks to use his phone. I ask to use his phone. Call Nora, get voice mail. Tell her I’m safe. Don’t feel too safe.
We see the smoke moving towards Staten Island. The guys point out the Staten Island Ferry is still running. I decide to go to the Staten Island Ferry. No sense staying on Manhattan. The Ferry isn’t my first choice, but not a lot of others.
Walk towards the ferry terminal. Underneath a vendor is selling snacks, film, souvenirs of New York. Looks like his normal spot. He’s Asian/MiddleEast but no one is hassling him. Go inside, but the ferries aren’t running anymore. Stay inside. At some point the second tower collapsed. But maybe it happened when I was in the park. I have no perception of time. Could have been 10 minutes, 20 or 60 in the terminal. No clue.
Talk to a threesome in the terminal. No further news. Subways closed, ferries closed. But now Staten Island ferry is open.
Winning the Lottery