NEW YORK (CNN/Money) -
Richard Grasso's resignation as head of the New York Stock Exchange has reminded investors -- and tech investors in particular -- that corporate governance lapses are still a major cause for concern.
Why tech investors, especially?
The sector has come under fire, mainly for the prevalence of stock options in compensation packages. Most tech companies argue that options are necessary to attract high quality employees. But critics say that options dilute shareholder value and that because options don't have to be expensed, some tech companies have gone a bit overboard.
Several institutional investors and shareholder activist groups are continuing to target tech companies for what they deem excessive compensation packages or other corporate governance problems.
"Excessive use of options is still very much an issue. It simply went from being flagrantly egregious to just plain egregious," said Ken Broad, co-manager of the Transamerica Premier Growth Opportunities fund.
Broad cites Adobe Systems (ADBE: Research, Estimates), PeopleSoft (PSFT: Research, Estimates), Apple Computer (AAPL: Research, Estimates) and Cypress Semiconductor (CY: Research, Estimates) as four companies that he would not own because of significantly sized options grants. Broad also criticized Adobe and Apple for allowing employees to exchange so-called "under the water" options for new ones. That's tech's equivalent of a mulligan in golf.
"When options are issued, the thought is that employees won't benefit unless the stock goes up. Re-pricing is not in the best interest of investors," Broad said.
“ Excessive use of options is still very much an issue. It simply went from being flagrantly egregious to just plain egregious ”
Ken Broad, co-manager of the Transamerica Premier Growth Opportunities fund
Gregory Taxin, CEO of Glass, Lewis & Co., an independent research firm focused on corporate governance issues, said that eBay (EBAY: Research, Estimates) is also guilty of issuing too many options, even though it is widely acknowledged as a tech company that has done extremely well in recent years.
Taxin estimates that eBay spent about $1 billion on options grants last year, even though its net income was only $260 million. "That's an exceedingly excessive compensation program," Taxin says.
Other companies that Taxin cites as having extremely high compensation packages for senior executives despite relatively poor financial performance are Broadcom (BRCM: Research, Estimates), Ciena (CIEN: Research, Estimates), 3Com (COMS: Research, Estimates) and EMC (EMC: Research, Estimates).
And Calvert Group, which runs several socially responsible mutual funds, said that tech companies Oracle (ORCL: Research, Estimates), Computer Associates (CA: Research, Estimates), Qwest (Q: Research, Estimates) and Network Associates (NET: Research, Estimates) do not pass its corporate governance screens so it does not own any of these stocks in its funds.
Daniel Boone, managing partner with Atlanta Capital, which runs the Calvert Social Investment Equity fund, says his biggest problem with the use of options is that options often force tech companies to continue buying back shares in order to offset dilution instead of using that cash for other purposes, such as dividends.
"Why not return some cash to shareholders instead of having to always buy back shares?" Boone said.
Still, it is worth noting there has been some improvement as of late on the corporate governance front.
Siebel Systems (SEBL: Research, Estimates) settled a lawsuit against it last month by the Teachers' Retirement System of Louisiana. The pension fund alleged that Siebel granted too many options to senior executives, including CEO and founder Tom Siebel, and that the company issued some of the options below market value without expensing the price difference.
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As part of the settlement, Siebel will now disclose the annual value of stock options granted to directors and five senior executives.
And this year, Microsoft (MSFT: Research, Estimates) has announced a flurry of shareholder-friendly moves. It began paying a dividend and announced last week that it was raising it. The company is also ending the practice of giving out stock options and said Thursday it was increasing the size of its corporate board from eight to ten members, nominating Helmut Panke, the chairman of German automaker BMW, and former AT&T CFO Charles Noski.
Nell Minow, editor of the Corporate Library, a research firm focusing on corporate governance, said Microsoft's actions should spur others in the tech sector to make improvements. In particular, Minow said she hopes other tech companies emulate Microsoft's decision to increase the size of its board.
Much of the excessive compensation problems are because tech companies have relatively small boards with few outsiders. "Traditionally, the tech sector has been at the bottom of corporate governance ratings because of small boards with interlocking relationships, such as company executives and venture capitalists that invested in the company," she said.
Hopefully, tech companies will continue to make governance improvements. And hopefully investors won't ignore these issues just because tech stocks are doing well again.
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