Silicon Valley Fears Narrower Pay Options Will Deter Highfliers

Poor Jerry Sanders. Here’s a guy who rose from the streets of Chicago, founded one of the world’s great integrated circuit companies, employs 11,500 people, and now finds himself in hot water over his pay.

Maybe it was the Rolls Royce, which is his company car. Maybe it was his insistence on living in Bel-Air and commuting several days a week to Advanced Micro Devices headquarters in Sunnyvale. Maybe it was the roller-coaster ride offered by the company’s stock, which has made some holders seasick.

All these things have contributed to Sanders’ ongoing flap with the California Public Employees’ Retirement System, the giant pension fund. But the to-do over Jerry Sanders isn’t just another case of CEO greed, because it turns on something very close to the heart of Silicon Valley--stock options.

At long last, the treatment of options for corporate chieftains is changing, and nowhere will the importance of these changes be felt more deeply than in the part of Northern California where stock options are the talismans that seem to make technology bloom.

The question is whether these changes will merely discourage boardroom excess, or whether they will also stifle the kind of start-ups for which Silicon Valley is justly famous. To understand all this, let’s get back to Jerry Sanders.

Like many big wheels, he gets stock options, which are rights to buy AMD’s shares at a given price. The interesting thing about options is that, unlike actual stock or (God forbid) cash, the company doesn’t have to charge their value against earnings.

Now, the idea of stock options is that they enable executives to profit when shareholders do, from higher stock prices. This is supposed to be a good incentive (assuming $1.5 million in cash didn’t do the trick for Sanders in 1991).

But in Silicon Valley, a funny wrinkle has become especially popular. It’s called “repricing,” and it involves lowering the price--the strike price--at which the option holder can buy his company’s shares.

When AMD’s stock price fell, for example, the company lowered the strike price of the options it had granted to employees, thus protecting their profit. This was pretty good for Sanders, as described in the Crystal Report, the witty newsletter published by corporate-compensation expert Graef S. Crystal.

“Some $35 million of Mr. Sanders’ exercised and unexercised option gains were derived, in no small measure, from the fact that his previously granted stock options were swapped--or to use the new, politically correct word for a swap, ‘repriced’--six times in six years,” Crystal writes. He adds that this dropped the strike price “of at least some of his options from $29.38 per share all the way to $4.25 per share.”

Crystal calls this and other aspects of Sanders’ compensation “obscene.” CalPERS has launched a proxy fight to get an outsider named chairman. Five New York City pension funds are also campaigning for change at AMD.

Ben Anixter, AMD’s vice president for external affairs, claims to be “mystified.” He says AMD has achieved a compound annual return of 16.3% in the last 20 years and posted sharply higher earnings in 1992, when it achieved a 27% return on equity. In other words, Sanders has earned the Rolls Royce.

Well, not exactly. In 1984, AMD traded as high as $44.125 a share. Last week it closed at $23.75. So a lot depends on when you bought. Since 1988, according to Crystal’s analysis, AMD’s performance has been dismal. It bounced back some last year, but so have chip makers that didn’t have Rolls Royces. AMD has benefited from plummeting personal computer prices, which have stimulated demand for products containing its microprocessors.

More important than the Rolls--or the proxy fight--are the treatment of stock options by the Securities and Exchange Commission and the Financial Accounting Standards Board. The SEC now requires that when options are repriced, companies disclose this for their highest-paid people in onerous detail.

Here’s where Silicon Valley comes in. Companies such as AMD claim that if they can’t reprice options, valued employees will go to work for competitors, whose stock is probably just as beaten down, and who can offer fresh options at the lower price.

Maybe so, but this certainly shouldn’t apply to a chief executive such as Sanders, who would benefit from AMD’s enhanced competitiveness even if he only repriced the options of his minions.

Far more serious is a proposal that FASB will publish this spring to make companies charge their earnings for the market value of options issued to employees. This would discourage lavish option giveaways, sure. But would it also have some nasty side effects in Northern California?

For Silicon Valley capitalists, options have almost religious significance. Using options, little start-ups can lure big talent with the prospect of a big payoff later.

Even state Treasurer Kathleen Brown, a CalPERS board member who is no friend of high CEO pay, opposes charging options against earnings. After all, share prices are already discounted (at least theoretically) to reflect dilution by options.

In my book, FASB should do it anyway. Its current proposal calls for options to be charged only when issued, not every quarter or year. Start-ups would just show bigger early losses, which no one pays any attention to anyway. FASB’s plan would discourage corporations from throwing around options as if they’re free, even as it makes financial statements fairer and brings some intellectual consistency to compensation accounting.

Best of all, when options are repriced, earnings would have to be charged all over again. That might help keep executives such as Jerry Sanders from profiting when their shareholders don’t.