Trustmark, Walgreens Join 'Clean Stocks' List

Southwest Airlines: Grounded

I suspected options accounting might present problems for Southwest, and it did. I think the issue is serious enough to keep the company off the Clean Stocks list -- especially because it's facing future pay pressures that will put options front and center.

The problem isn't that Southwest is stuffing its executives' pay envelopes with options, an all too widespread problem these days. Executive cash compensation is below the airline-industry average at Southwest: Chairman Herb Kelleher received just $431,000 in salary and $170,000 in bonuses in 2002, and CEO James Parker was paid $305,000 in salary and $287,000 in bonuses. And Southwest doesn't overdo options to compensate. Kelleher and Parker each received option grants equal to just 0.02% of all options granted to employees in 2002.

That's about what I'd expect from a company that's up to the most exacting standards of corporate governance. Auditor Ernst & Young make almost all of their money from auditing the books without big consulting contracts as an incentive to look the other way on accounting infractions. Even by my conservative count, eight out of 12 members of the board qualify as independent.

The company's options accounting, however, doesn't meet the same high standards.

Southwest doesn't count options as compensation. In 2002, counting options as compensation to employees would have turned Southwest's earnings of 30 cents a share into 23 cents a share. That's a 23.3% swing.

And that's too much, considering that options are a key reason why Southwest's labor costs are below those of other airlines. The company historically has made up the difference -- and then some, considering the stock's performance -- with options. Employee gains from options have helped the company win the kind of flexible scheduling and high productivity from Southwest's intensely loyal employees that give the company a cost advantage over competitors.