ScanSource Inc. approved a new form of compensation for its executives today after shareholders sued the company amid an options backdating scandal. The new compensation plan calls for restricted stock to be used instead of options, which the ScanSource CEO Mike Bauer said is common among other public companies in their industry. In fact, restricted stock has become more and more popular ever since Microsoft switched over not long ago. What's the difference? Well, stock options give you the right to buy shares at a certain price, but if the stock falls below that level, they expire worthless. Recent problems surfaced in instances where backdating occurs - that is, when these options are granted at "certain prices" well below the current market price at the time, making the options instantly worth millions in some cases. Restricted stock, on the other hand, is actual stock that is given to executives with a provision saying that they are not allowed to sell it for a certain amount of time (typically six months). This prevents any opportunity for backdating and forces executives to invest on a more long-term basis.

However, restricted stock isn't as widely used as stock options because they are disadvantageous to executives in many ways. First, they are taxed in the same year they are issued. Unlike stock options, which are taxed when exercised, restricted stock is treated just as normal compensation. Secondly, since restricted stock is actual stock, companies tend to issue much fewer shares than they would options. Although restricted stock can never expire worthless, this often limits the upside and leaves them exposed on the downside. Despite these problems, restricted stock may be the answer for shareholders concerned that executive interests are misaligned with their own. Perhaps we will see more of these trends in the future.

Mentioned Companies
ScanSource, Inc. (NDAQ:SCSC)

Bloomberg reported yesterday that stock sales by American executives exceeded stock purchases last month by the widest margin since 1987. Among the largest aggregate sellers were Microsoft's Bill Gates and Google's Eric Schmidt. We first profiled Google's massive insider selling back in September, when we noted that executives unloaded nearly $1.7 billion worth of Google shares during the six previous months. While many high-profile executives have indeed been selling a large amount of stock lately, there is debate as to whether this is due to a negative outlook on the economy or simply a move to diversify their holdings. Some argue that many executives, including Gates and Schmidt, sell shares on a fairly regular basis using a set program. In general, these programs tend to sell into rallies and buy into dips. Therefore, selling after this rally should come as no suprise to investors. Others, however, that economists are forecasting a slowdown in profits, and these sales are indicative of an upcoming slowdown or retracement in company performance. The answer may lie somewhere inbetween, however, such a large number of insider sales is not something that can be easily ignored.

Mentioned Companies
Microsoft Corporation (NDAQ:MSFT)
Google, Inc. (NDAQ:GOOG)

A federal court granted The California Public Employees Retirement System's (CalPERS for short) request last Thursday to block ex-UnitedHealth CEO William McGuire from accessing millions of dollars worth of unexercised stock options and his retirement plan pending a special review of shareholder lawsuits against McGuire and UnitedHealth Group. These lawsuits allege that the company backdated options granted to executives in order to inflate their value.

The first sign of major problems surfaced during the Spring board elections when several major shareholders witheld their votes. Although the encumbants were re-elected anyway, Mr. McGuire was eventually forced to resign due to these allegations - his last day as CEO was last Thursday. According to SEC filings, McGuire has over $1 billion worth of unexercised options, although UnitedHealth said the value of these options has declined significantly since last reported. The CEO's severance package also includes a pension of $5.1 million per year in addition to a $6 million lump sum payout. And finally, we can see from ExecutiveDisclosure.com that the company's executive compensation already surpasses that of its peers:

Clearly CalPERS and other shareholders have valid concerns. The stock has moved down over 20% this year, in part due to this options scandal. Perhaps when this cloud clears there will be hope for UnitedHealth Group to turn itself around and start generating value for its shareholders again. However until then, shareholder lawsuits and a SEC investigation are likely to keep shares depressed.

Mentioned Companies
UnitedHealth Group, Inc. (UNH)

IAC/InterActiveCorp chief executive Barry Diller responded to the widespread criticism he received after his pay topped the charts at more than $296 million in 2005, calling his critics "birdbrains". He insists that this criticism is undeserved; after all, the majority of his income (98%) for the year came from exercising options that he had obtained 11 years ago after he took over the then-risky HSN Inc. in St. Petersburg. Since then, he turned the troubled TV shopping network into a $10 billion multimedia conglomorate. Isn't this money well deserved?

He also expressed outrage at many corporate governance groups who automatically penalized his company, most notably the "D" rating that the Corporate Library issued. On that topic, he noted, "I think the whole consultant group should be flushed into the East River and no value loss would ever be seen by man". Moreover, he faced criticism from many in the media, including the New York Times which recently ran a story on his compensation that called him "the laziest man in America". Diller said the issue of governance is "completely misunderstood, certainly by the birdbrains that write about it. I mean their reactions to everything are so dim, and I am talking about The Corporate Library and I'm talking about these people that analyze these things and haven't a clue ... My problem with governance is that it's really hurting American business."

While this is true in some cases, there are many more instances of poor corporate governance. Clearly, many compensation committees failed to prevent the options backdating scandals, ill-defined bonuses (abusing regulation 162m), and countless other instances. Some executives, like Barry Diller, are unfairly targeted; however, perhaps this is a necessary evil in order to protect shareholders in the long run.

Mentioned Companies
IAC/InteractiveCorp (IACI)

Metropolitan Capital Advisors demanded today that Cyberonics (NDAQ:CYBX) Director Kevin Moore be immediately removed from the Board. The demand stemmed from a conflict of interest that Metropolitan called a "glaring violation of law and appropriate corporate governance practices". Apparently, Moore had a longstanding friendship with ex-CEO Robert Cummins - it turns out they were college buddies at Dartmuth. Soon after Moore joined the board in January of 2004, he was appointed to head the compensation committee. This conflict of interest ended up costing shareholders dearly.

The first major problems began on June 15, 2004, when Mr. Cummins managed to pull in $2.5 million overnight thanks to a conveniently timed options grant that we previously reported on. Then in 2005, Moore approved a raise for Mr. Cummins despite an existing contract with three years still left on it! That brought his salary up to $800,000 along with $17 million in additional option grants. And these were not options that were acquired when the company was in its infancy; rather, they were acquired in periods when shareholders were losing money.

If Metropolitan succeeds in removing Kevin Moore from the Board like they did Robert Cummins, they will finally have a clean slate to work with. They hope to then find a CEO that will be able to help lead the company return value back to the shareholders.

Mentioned Companies
Cyberonics (NDAQ:CYBX)

Board independence and executive compensation are issues experiencing more and more media attention lately, but what is being done to correct the problems? While regulators are working to enact new laws, these take a long time to enact and enforce. As a result, many activist and passivist investors have voiced their concerns recently (which led to the current media blitz). One of the most important instances occured on October 23rd when a coalition of pension funds with over $850 billion under management sent out letters to the top 25 U.S. companies by market capitalization expressing concern over executive compensation. In particular, the funds voiced their concern over the independence of the board committees that determine executive pay within a company. Often times these compensation committees also work closely with management in other areas; such relationships could lead to the inflation of executive pay at the expense of shareholders. How does this occur? In the end, these committees are often failing to prevent abuse of Regulation 162(m). This abuse is characterized by performance goals (developed by these compensation committees) containing vague vocabulary designed to maximize the liklihood of meeting goals. When these goals are achieved, bonuses are granted to executives (and they're even deductible!). The pension fund coalition hopes that these letters will remind investors to be mindful of executive pay levels as well as encourage companies and regulators to work to remove any conflicts of interest that may exist between management and shareholders. In the end, it may be shareholders that may have to take action through the use of publicity and proxy threats. After all, it was regulators that passed Reg 162(m) in an attempt to combat excessive compensation in the first place!

Public companies are structured in such a way that shareholder interests and management interests are seperated - at least that's the theory. Problems arise when management holds the position of Chairman, which often leads to their "friends" being appointed to fill the other seats. Shareholder interests are in great jeopardy when this happens because management has complete control and very little oversight. This type of situation can be particularly costly during mergers or acquisitions, when management interests can differ greatly from shareholder interests. Often times, management receives cash bonuses, severence packages, and other benefits that are not realized by shareholders. Occasionally, these benefits are offered by bidders who want to restrict the marketing done to sell the company in order to assure a lower cost of acquisition.

One such instance of this taking place is the Lone Star buyout by private equity firm Lone Star Funds. While the value of such a transaction should be over $40 (based on the analysis of a hedge fund), the company agreed to a buyout priced at only $27.10. Moreover, the company did not solicit any bids until after the company agreed to the $27.10 buyout with a contigency stating that Lone Star Funds would have the right to match any future bids! Combined with an $18 million breakup fee, the company is giving little chance for other bidders to make a higher offer. Why would a company do this? Well, management has a lot of money vested in stock options that will expire soon. If the buyout goes though, the CEO alone stands to make $80 million through the exercise of risk-free options. However, if the buyout fails (or if they would have had to consider other bids) he would have had to spend $14 million to exercise those options with no guarantee that a buyout would take place anytime soon.

Instances like this can cost shareholders a lot of money while management benefits. The problem can be traced back to the fact that management and the board are not adequately seperated - a problem which not only affects M&A decisions, but also executive compensation, performance metrics, capital allocation, and many other things that can cost shareholders. This is a growing problem that is currently policed by hedge funds, but should be addressed by Corporate America before it grows.

Mentioned Companies
Lone Star Steakhouse & Saloon Inc. (NDAQ:STAR)

Richard Causey, the last executive implicated in the downfall of Enron, was sentenced today to five and a half years in prison for his involvement in the scandal. The Chief Accountant who signed off on manipulated accounting documents plead guilty in December 2005 to securities fraud and agreed to repay $1.25 million in damages and forfeit over $250,000 in deferred compensation. The judge showed no mercy at trial as he sentenced Causey to just a half year below the maximum and imposed additional financial penalties to the judgement, although prosecutors opted not to go after his $950,000 home in a Houston suburb. Meanwhile, CEO Jeff Skilling was order to report to prison in Minnesota on December 12th to begin his 24 year sentence, although he plans an appeal.