Thursday, May 25, 2006

Talleyrand on Options Backdating

Talleyrand on Options Backdating: One of the more interesting stories in the financial pages these days is the news surrounding the options backdating probes. As the options backdating story has continued to unfold, some have questioned whether or not there is anything wrong with options backdating. For example, the wsj.com law blog has a May 23, 2006 video post containing a debate between a business school prof and a CNBC reporter on the topic. Options backdating is obviously not harmless -- the revelation of options backdating has already proven damaging to at least some of the companies caught up in the probe as they have had to restate their past financials to reflect their true compensation costs. But even beyond the restatement threat, there is a particular reason why the options backdating story has gained momentum in a way that stories about excecutives' use of corporate aircraft or gold-plated pensions have not. The peculiar feature of the options backdating scandal is captured in the following epigramatic statement of Talleyrand:


If a gentleman commits follies, if he keeps mistresses, if he treats his wife badly, even if he is guilty of serious injustices toward his friends, he will be blamed, no doubt, but if he is rich, powerful and intelligent, society will still treat him with indulgence. But if that man cheats at cards he will be immediately banished from decent society and never forgiven.

The whole point of options-based compensation is to align executives' financial interests with those of investors. Options-based compensation should subject executives to the same investment risk as investors. But back-dating options to ensure that executives gain in a way that investors cannot not only breaks the alignment between executives' interests and those of investors, it unfairly stacks the deck in the executives' favor. It is, in Talleyrand's memorable phrase, cheating at cards, which no one will ever forgive. I believes the options backdating story has legs and has a long way to run.

Talleyrand made the statement above to Napoleon Bonaparte to upbraid Napoleon for his treachery in tricking King Charles IV and Queen Marie Luisa, the Bourbon monarchs of Spain, to abdicate their thrones in favor of Napoleon's brother Joseph. The incident not only led to a falling out between Napoleon and Talleyrand, but it was the prelude to Napoleon's disastrous Peninsular War that led to the first of Napoleon's military defeats at the hands of the Arthur Wellesley, later First Duke of Wellington.

Talleyrand himself may or may not have known about cheating at cards from first hand knowledge, but he certainly knew about trading in securities. At the time of his death, Talleyrand had accumulated an immense fortune, only a potion of which was attributable to bribes and gratuities from foreign governments. A substantial part of his fortune came from trading in shares of companies based on inside information he obtained from his position inside the Napoleonic government and the Bourbon restoration. For more about Talleyrand, I recommend Duff Cooper's classic 1932 biography of Talleyrand.

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