proposal to give managers significantly more stock options got an unexpected vote of confidence Wednesday from the the nation's leading proxy adviser.
Institutional Shareholder Services recommended that shareholders vote for eBay's options plan this year, despite saying last year that investors should vote down similar increases in the number of shares eBay can grant as options.
The proposal comes as stock options are under scrutiny by investors, accounting experts and public-policy makers. Because stock options tend to reward employees and managers for short-term stock fluctuations, options have been linked to corporate scandals at
, where questionable or illegal steps allegedly were taken to boost share prices.
Yet eBay shows no signs of letting up on its options binge, despite the scrutiny.
The company's board is
asking shareholders to approve a greater-than-50% increase in the number of shares the company can award under its current stock-option plan for employees and managers. The proposed increase, some 14 million shares, is tantamount to about 4% of the company's outstanding shares. Shareholders approved similarly sizable increases in each of the last two years. They'll have a chance to vote on this proposal at the company's annual meeting in Orlando on June 26.
Company representatives didn't return calls seeking comment about the proxy vote or the ISS recommendation.
ISS is basically the only game in town when it comes to proxy recommendations for institutional investors, and its recommendation may well carry weight with investors. So what's behind the change of heart at ISS? This year's run-up in eBay shares means the cost of the options comes in below a cap set by ISS according to a proprietary formula it uses. Also, eBay has promised to seek shareholder approval before repricing the options.
Yet investors and their advocates have become increasingly vocal about the role options play in diluting shareholder value. Meanwhile, a consensus has developed that public companies must report options costs in some fashion on their balance sheets. And a very weak labor market has undercut the traditional argument of options as a hiring inducement.
eBay has been one of the more prolific users and beneficiaries of options. In the past three years, the company has awarded a net grant -- total granted options minus canceled options -- of 32 million options, which is equivalent to more than 10% of the company's currently outstanding shares. The company gained $347 million last year from options-related benefits, which was more money than the company posted in free cash flow.
The company awarded a net grant of 11.8 million options last year alone, which was equivalent to more than 4% of its outstanding shares at the beginning of last year.
ISS took into account eBay's past options grants in making its recommendation. But much of the proxy adviser's formula depends on the estimated value of each option compared with the company's overall market capitalization, a ratio it calls "shareholder value transfer." If a company's stock price increases faster than the average value of its options grants, then it can award more options without hitting ISS' cap.
That's precisely what happened with eBay, according to ISS. The proxy adviser estimated that the value of eBay's options, including those granted but unexercised, those proposed under the current plan, and those available for grant under previous plans, was about 11.5% of the company's market capitalization. Last year, ISS estimated that the value of eBay's potential and actual stock options was about 13% of the company's market capitalization.
eBay's stock price has gone up about 71% in the last year even as its share count also has increased.
"This year, the
shareholder value transfer is lower as the market cap has increased more than the cost of options," said Rajeev Kumar, a senior analyst at ISS, in an email. "Also, the allowable cap for eBay this year is higher than last year. This again has helped the company in cost comparison."
Although ISS recommended that shareholders vote down two proposals to increase eBay's options pool last year, investors passed the two proposals overwhelmingly. But with options under greater scrutiny now, the proxy adviser's recommendation may give cover to institutional investors who vote in favor of this year's plan.
Investors opposed to eBay's options practices already faced a tough fight.
One of the obstacles to opposing the options proposal at eBay is that a large portion of the company's stock is still held by company insiders. Pierre Omidyar, the company's founder and chairman, controls 20% of the company's stock. Company CEO Meg Whitman controls more than 2% of eBay's stock. In all, eBay's directors and officers control more than 23% of the company's stock. Additionally, former president Jeff Skoll, who no longer has an active role at the company, owns another 10% of eBay's shares.
Assuming that all those shares are voted in favor of the board's proposal, opponents would have to garner nearly 75% of the remaining shares outstanding to vote down any proposal. It's doubtful that critics would be able to amass that kind of opposition, some analysts say.
eBay shares have risen more than 43% since the beginning of this year, as the company has continuously posted record sales and earnings. Although the company's stock largely stagnated last year, it never saw as much of a selloff as some of its Internet brethren.
The company's stock performance is a powerful disincentive to investors thinking about making a fuss about its options practices, analysts say. "I doubt anyone cares anymore," said one fund manager, who also asked not to be named. "If the stock goes up, people will care less and less. It's all 'What have you for me lately? How much money is in my pocket?'"
And even if individual investors decide to make an issue of the options vote, they aren't likely to get very far without institutional investors. But the mutual funds that hold big stakes in eBay and other prolific options dispensers have been largely silent on the issue, said a second fund manager, who also asked to remain anonymous. "
-- you don't see them taking up this issue," said the second fund manager. "They buy the stock because it's going to beat expectations."
A representative for
, the institutional holder with the largest stake in eBay, declined to comment, saying that the mutual fund company doesn't disclose its positions on proxy votes. Representatives of
Van Kampen Investments
, which also hold sizable stakes in eBay, didn't return calls seeking comment.
Some opposition to the proposal could be forming, though. The AFL-CIO, whose affiliated unions control pension funds worth some $400 billion, could turn out to be a significant opponent. The umbrella organization for the nation's unions generally opposes options plans at companies where options exceed 10% of outstanding shares and at companies that do not expense options costs. eBay gets strikes on both of those counts.
Through its affiliate unions, the AFL-CIO has pushed a number of shareholder votes involving corporate governance reforms this year, many of which have gained shareholder approval. Among the targets have been companies' options practices.
"The cost of these plans to shareholders" is the AFL-CIO's main reason for opposing them, said Brandon Rees, a research analyst at the organization. "Coming out of the worst bear market since the Great Depression, shareholders are feeling a lot more stingy."
But despite that sentiment, ISS' recommendation could make this fight a losing battle. "It's a noble fight, but like many noble fights, there's no ear to listen to it," the first fund manager said.