Colin Barry

Option Backdating at UnitedHealth (BAV, Wednesday, Week 9)


CEO compensation for Bill McGuire:
-- "extraordinary" => cash salary/bonus = $45M, options = $300M
-- BUT he built UnitedHealth. Market cap has grown by a factor of 50 under his tenure (1991-2005); shareholders overwhelmingly approve of him and his compensation package.

How to account for stock options? Fair value.
Intrinsic value:
-- Expense = 0 (non-cash charge)
-- Footnote on annual report
-- Appears as dilution.

Fair value:
-- Comparability between firms
-- Matching principal ("cost" of options spread over vesting period)
-- Use options pricing methodology (Black Scholes) to value options at issuance

To other huge problem: backdating.
Retroactive choice of grant date => greater dilution for shareholders, greater moral hazard
Is it illegal? No, not if it's transparent --- just issuing options at below-market strike price...
Another controversial trend: "spring loading" => timing options issuance to immediately precede good news

Is this a big deal for UnitedHealth? Should it impact valuation?
Market cap declines by $20B. Impact of backdating: maybe $400M.
Maybe fundamentals unaffected, but:
Management distraction from lawsuit, SEC investigation, trust in management/board (worse because UnitedHealth is an insurer), possible departure of high-performing CEO, political pressure, etc.
A fine mess...