October 20, 2004
FOR IMMEDIATE RELEASE

Contact: Teresa Hendrix
(805) 756-7266

Cal Poly Professor’s Research Shows Trouble For Companies
Giving CEOs Large Stock Option Packages

SAN LUIS OBISPO – Companies that give their chief executives lavish
stock option packages as part of their compensation are more likely to
wind up in accounting trouble later on, according to a study by Cal Poly
Accounting Professor Jap Efendi and colleagues.

The study, by Efendi, Texas A&M Business Professor Edward Swanson and
Texas A&M doctoral candidate Aup Srivastava, has been submitted to the
leading academic accounting journal, The Accounting Review. Although
still under review at the academic journal, the study has already
received attention in the financial press, including Business Week
Online, CFO.com and the Financial Times of London. CalPERS, the
California Public Employees Retirement System, also recently placed the
study online on its Web page forum on Executive Compensation.

Efendi and colleagues studied data from 100 publicly traded companies
covering fiscal years 1999-2001 regarding the relationship between their
chief executive officer compensation packages and subsequent accounting
restatements.

“In accounting restatements, the company announces its accounting
figures, but then comes back later and says its numbers were wrong, that
they were misstated,” Efendi explained.

Restatements, he explained, are public acknowledgements that companies
have committed violations in Generally Accepted Accounting Principals
(GAAP) in their prior financial reports. A large majority of them result
in lower reported earnings, suggesting these misstatements were
intentional manipulation, Efendi said.

Some of the companies in the news recently for issuing accounting
restatements include Enron, WorldCom, and Computer Associates.

Efendi’s study found that companies which gave CEOs large stock option
packages as part of their executive compensation were much more likely
to issue accounting restatements. This finding supports the assertion
that excessive stock options encourage executives to inflate their
accounting numbers and, therefore, stock prices, according to the study.

“We also found that CEOS in restatement firms exercised more stock
options in the years when the earnings were manipulated,” Efendi said.

The larger the portion of CEO compensation given in stock options rather
than salary, the more likely the company was to have an accounting
restatement, according to the study.

“To have CEO compensation in stock options 80 times (the value) of
annual salary was not uncommon for many of these companies,” Efendi
said. “We found that the more excessive the stock options package, the
more likely companies are to manipulate their accounting numbers.”

Stock options, Efendi explained, allow holders to make money only when
the price of stock rises. Employees can generally exercise their stock
options after holding stock a designated amount of time, and only make
money when company stock prices rise.

Rosy accounting reports released to the public generally tend to support
stock price increases. However, when accounting manipulations are
uncovered and accounting restatements issued, shareholders suffer from
the subsequent fall in stock prices.

“There has been a very hot debate in the business community over stock
options. Some people say granting large stock options to CEOs is good,
because it makes them a ‘part owner’ in their firms. The other part of
the debate holds that stock options can be harmful, because they
encourage CEOs to manipulate accounting to inflate earnings and stock
prices just long enough to take the money and run,” Efendi said.

“Though there has been a lot of debate, our study is the first to
empirically prove that granting an absurd amount of stock options to
executives turns out to be a bad idea and may be an incentive for
management to manipulate accounting and profit at the expense of
shareholders,” Efendi said. “In the 1990s, companies were handing out
stock options like candy.”

Efendi is now studying whether sophisticated investors known as “short
sellers” can see through earnings manipulations before they are
uncovered and publicized in accounting restatements.

To read the Business Week Online story on the study, visit:
http://www.businessweek.com/bwdaily/dnflash/may2004/nf20040521_6147_db016.htm

To read the CFO.com story on the study, visit:
http://www.cfo.com/article.cfm/3014835/c_2984789?f=CFO_Careers_topstories


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