Internet auctioneer eBay ( EBAY) is coasting toward next week's shareholder meeting with its shares near their 52-week high -- and with key support for a plan to expand by 50% the number of stock options the company can give managers and employees. But not everyone is signing off on eBay's proposal to sweeten significantly what is already one of the most generous options plans in the industry. At least one independent reviewer says that eBay's plan will lead to an excessive annual giveaway worth four times as much as the company's net income last year. That's the opinion of newcomer proxy-advisory firm Glass Lewis. The firm, which recently enlisted former top SEC accountant Lynn Turner and signed the country's biggest public pension fund as a client, described eBay's options practices as "beyond the pale." Glass Lewis is faulting the recommendation that eBay got from leading proxy adviser -- and rival -- Institutional Shareholder Services. Last week, ISS
recommended that eBay shareholders vote in favor of the company's plan to increase options, saying that the value of the proposal came in under ISS' prescribed cap. eBay's options-granting practices are getting close to a "red line," acknowledged Patrick McGurn, senior vice president of ISS. But he defended ISS' proxy recommendation, saying that the method ISS uses to analyze options plans is the same one most investors use. Another important opinion on eBay's option proposal is expected this week from the California Public Employees Retirement System, or Calpers, the nation's largest public pension fund. Calpers, which is expected to announce how it's voting Monday, is an ISS client but recently signed on with Glass Lewis as well. Gregory Taxin, Glass Lewis' CEO, says that ISS' analysis is simplistic and ill-founded, based on a market cap swollen by a 43% run-up in share price since the beginning of the year. A favorite company in the newly invigorated Internet sector that is now found in many mutual fund portfolios, eBay shares trade just shy of $100, close to their 52-week and all-time peaks. Worse, Taxin said, ISS' method of evaluating options plans can be "gamed" by savvy executives and compensation consultants who can do what eBay did -- buy the key to the company's analysis.
Glass Lewis opposed eBay's options proposal after the plan failed four of the 10 criteria the company used to judge the plan, Taxin said. Among the problems with the proposal: Glass Lewis estimates that eBay will hand out about $1 billion worth of options this year, which represents about four times its reported net income in 2002. "You can't run a business in which you are giving away four times the net income that you generate in the form of options grants," Taxin said.
asking investors to approve a greater than 50% increase in the amount of shares it can grant under its current options plan. The proposed increase -- some 14 million shares -- amounts to more than 4% of the company's outstanding stock. All of this comes at a time when mounting scandals have led to criticism of companies' open-handed options policies. Among the complaints about options: the dilution of shareholder interest and the skewing of executive behavior. Reacting to this sentiment, accounting regulators are likely next year to require all companies to expense the cost of stock options. Some companies have already begun to expense options on a voluntary basis. In the meantime, some technology and Internet companies such as, Intel, Siebel ( SEBL) and Yahoo ( YHOO) have moved to limit their outstanding options. eBay has made no such moves. And like other technology companies, eBay has resisted expensing stock options.
Awash in OptionsLast year, for instance, eBay gave employees a net grant of 11.8 million options, which amounted to about 4.3% of the outstanding shares the company had at the beginning of 2002. That was a far greater proportion of outstanding shares than high tech peers such as Intel ( INTC), Cisco ( CSCO) and Amazon.com ( AMZN) handed out last year. And eBay doesn't seem to want to curtail its options habit. After getting shareholders to vote for sizeable increases in its options pool in each of the last two years, the company is
Companies still argue that options are needed to snag needed technical talent. But it's becoming a hard sell at a time when layoffs and tepid hiring have made Silicon Valley's labor pool neck deep in technical talent. "You can look at a company's stock plan in isolation all day and the numbers are eye-popping," says McGurn of ISS. "But if that's the level of analysis you get into, you're not going to have anything in your investment portfolio."
Ratings GameISS sells its analyses of companies to investors who use the information to determine whether they will invest in the companies and how to vote on proxies. The proxy-advisory firm recently began offering a corporate governance scorecard that rates each company's governance according to a number of criteria. But ISS allows companies to pay for access to its corporate governance formula, which they can use to determine how certain policy changes will improve their governance score. By potentially giving grades to the same companies that it consults with, ISS has opened itself up to charges that it has an inherent conflict of interest. Meanwhile, critics have charged that companies can "game" ISS' scorecard, making superficial changes to improve their score, rather than fundamental changes for the benefit of shareholders. As with its scorecard, ISS also allows companies access to the formula it uses to determine whether to recommend an options plan to shareholders, a feature it calls ISSue Compass (Compensation Plan Evaluation). In a promotional pamphlet on its Web site, ISS says that by using ISSue Compass, companies can plug in different variables to determine what plan might meet ISS' approval. "As compensation faces increased scrutiny by shareholders and the media, the potential for embarrassment is magnified," ISS said in the pamphlet. "With Compass, you can adjust plan features before you finalize your proxy statement." That companies can buy access to ISS' formula and play around with it to tweak their results points to one of the fundamental flaws in the way ISS judges options plans, said Glass Lewis' Taxin.
"ISS' analysis is quite elementary," Taxin said. "It's easily gameable for those who understand how it works. Every lawyer that does compensation work is familiar with this thing." ISS' McGurn denied that giving companies access to the options formula allows them to "game" the system. "This allows them to come within the boundaries of the allowable cap," McGurn said. "The net effect is that it lowers the potential value transfer to investors." eBay is among those companies that has paid for access to ISS' options formula. However, McGurn said that eBay also paid for access to the product prior to last year's proxy. Despite that, ISS recommended last year that eBay shareholders vote against eBay's proposals to increase its options pool. eBay representatives did not return calls seeking comment about its proxy proposal, its relationship with ISS or its reaction to Glass Lewis' recommendation.
The annual cost of eBay's options is excessive relative to the company's financial performance. Based on eBay's track record, Glass Lewis estimates that the company will hand out nearly 16 million options this year. The average lifetime value of each of those options is about $75, according to Glass Lewis estimates. That translates into an options grant worth more than $1 billion. In addition to being four times eBay's earnings last year, that amount is nearly equivalent to its total revenues in 2002 and nearly three times its operating income. In contrast, among eBay's peer companies -- a group of S&P 500 companies selected by Glass Lewis that operate in similar business segments as eBay and have roughly similar market capitalizations -- the average annual cost of their options programs was about 1.3% of revenue. Not only is eBay's program more than one standard deviation from 1.3%, it's a "complete outlier," said Taxin.