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Subject:  Re: The WSJ: New Look, Same Blind Spot Date:  1/4/2007  8:37 PM
Author:  WatchingTheHerd Number:  200322 of 603895

crassfool writes:

However, Apple is not a strong example. Consider that at the time of the options backdating, the leadership was a bunch of guys who had pulled off a takeover after their company was bought by Apple. They went from a company that was drifting sideways to one that was in serious danger of going down the tubes, and it looks to me like the options contributed to keeping them on board, especially the technical leadership.

From the books and articles I've read since about 1988, I have my doubts about Jobs. Jobs gets much of the public acclaim as the technical visionary of Apple. However, Apple has been blessed with some AMAZING engineering talent where the rubber meets the road at crucial times in their history (the team of 12-16 core engineers that created the Macintosh being the prime example) who were treated pretty poorly from a financial and cultural standpoint by Apple management. They worked hard because they believed in what they were doing, not because management was dangling financial incentives. I recall stories about the Macintosh effort that said most of the core team probably made maybe $60-70k/year from 1982-1984 but worked 100-120 hours/week the entire time and got NOTHING from Apple in terms of options.

In short, my take on Apple is that its darkest days were typically caused by marketing-focused executives who were able to lead the company during stable periods but lacked the technical expertise and vision to steer the company through the routine technology "lurches" that occur in Apple's industry. Apple didn't survive these downturns by managers like Jobs actively coming in and PULLING the company from under the water, they survived when INCOMPETENT management left and allowed the core of technical expertise to quickly bob back to the surface. It might look the same to the casual observer but the underlying organizational reasons are vastly different.

To the extent options backdating was taking place in Apple to stabilize the firm, I doubt it helped stabilize the talent that wound up producing the iPod or designing the iTunes on-line retail experience or porting the OSX operating system to Wintel in 18 months without a hitch. (Disclaimer: I obviously bring a pretty pro-engineer, dubious-executive slant to the analysis...)

Now the bad thing about the backdating shenanigans is supposed to be the dilution of shareholder value. I don't know how to calculate the loss due to dilution by those stock options, but during the subsequent years, AAPL went from the 4 - 6 dollar range to the 60 - 85 dollar range. As a long-term AAPL holder, I am happy enough with the stock performance that I find it impossible to get upset about the dilution.

You mention one of two key problems I see with the backdating practice besides the obvious legal / ethical concerns. From a dilution standpoint, part of the danger is the sheer size of American companies is so great that boards and shareholders are losing perspective on things back at the human level.

Since they're in the news, let's take Home Depot as an example. Today's front page article on Home Depot in the WSJ mentioned that besides the ongoing personality battle over their ex-CEO, Home Depot also faced backdating backlash. Per the article, the report issued by its board in December found their 20-year habit of backdating had understated executive compensation by $200 million.

For a stock that has split 9 times in 21 years, $200 million spread over 20 years seems like a small dilution of shareholder equity. If you even try to come up with a sense of the magnitute of the questionable compensation on a per share basis, you might spread $10 million across 2,040,000,000 outstanding shares and you get a "backdating" tax of $0.49 per share per year. A half of a penny per year. Hardly worth worrying about, I guess, right?

Wrong. In my mind anyway. This is the real-life equivalent of the scheme from Office Space, the cult-classic spoof of life in high-tech corporate America, where three software engineers come up with a scheme to steal the "rounding errors" on interest calculations from banks and deposit them in their own account. The perfect crime -- stealing tenths of a penny at a time where the theft is below the precision of the accounting systems adding the numbers up at the end of the day.

The only difference is Office Space was a movie. Boards and CEOs and CFOs who participated in backdating were stealing from shareholders in real life knowing that most investors wouldn't even think about it as long as their own stock was going up. They depended on it. As long as everyone's making money, a few of us stealing some of the money being made wasn't a problem.

The other problem with the options backdating process is, as Home Depot and others are finding out, it resulted in understating the true compensation of the firm's executives. Given that executive pay growth has been closer to exponential than linear, in the case of Home Depot, it's probably safe to assume most of that $200 million in understanded executive pay reflects dollars collected over the past (say) 5-10 years. Well, that overlaps quite well with the tenure of the now-ousted CEO who was tossed because of the combination of HD's stalled stock price and his ever-growing pay. Well, would the board and shareholders become more vocal earlier in the process if they had a more clear picture of how much cash Nardelli was actually draining from the firm's coffers?

THAT'S the real point. At a time when executives claim they are worth huge salaries, board and shareholders may be only looking at the tip of the iceberg when deciding if the exec is doing a "good enough" job to justify $6 million per year when in fact he's costing them $10-12 million. Or $21.6 million like Nardelli collected from Home Depot in January 2006 -- only one year before they decide to toss him overboard.


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