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A SPECIAL ANNEX NEWSFLASH

Updated 2/26/04, 5:10 p.m. MST (adds "Recent Examples")

Analysis of New IBM Stock Option Rules

Greed De-clawed

Step in Right Direction, But No Panacea

PHOENIX, Feb 25 - Sam Palmisano, IBM's CEO, is continuing his efforts to remold IBM back to its old conservative corporate values, and to distance himself from his predecessor's "Era of Greed" (1997-2002).  Big Blue announced yesterday a new stock options plan under which its top executives could not profit from the options unless the price of the IBM shares were to rise at least 10% (click here for details).  

The IBM move de-claws the greed that flourished under the former IBM CEO, Lou Gerstner.  It reverses the previous rules under which Gerstner and his lieutenants were granted stock options at prices substantially below the market.  We calculated that Gerstner's average costs, for example, were about $16 when the average market price was about $100 (in the in 1997-2001 period - click here to view the table, and click here to see same recent examples).  

As a result, we wrote in April 2002, Gerstner even "outLayed Ken Lay" (the former Enron CEO and his top 6 executives) in terms of personal greed at the expense of general shareholders (see "Sir Lou OutLayed Lay!", Apr 1, 2002, from which the following chart comes).

Text Box:

Recent Examples

Here are some recent examples of substantial discounts that Gerstner and his top lieutenants have had relative to the market price of the IBM stock.  These five cases involve two IBM directors and two Senior VPs:

Date Insider Shares Transaction Value
 
30-Jan-04 TROTMAN, ALEX
Director
8,000 Option Exercise at $23.25 - $27.015 per share. $201,000
30-Jan-04 TROTMAN, ALEX
Director
8,000 Sale at $98.9361 per share. $791,488
26-Jan-04 NOTO, LUCIO A.
Director
800 Option Exercise at $23.25 per share. $18,600
26-Jan-04 NOTO, LUCIO A.
Director
800 Sale at $98.78 per share.
$79,024
20-Oct-03 DONOFRIO, NICHOLAS M.
Senior Vice President
34,036 Sale at $89.1957 per share. $3,035,864
20-Oct-03 DONOFRIO, NICHOLAS M.
Senior Vice President
34,036 Option Exercise at $13.36 per share. $454,720
18-Jul-03 DONOFRIO, NICHOLAS M.
Officer
34,000 Option Exercise at $13.36 per share. $454,240
18-Jul-03 DONOFRIO, NICHOLAS M.
Officer
34,000 Sale at $83.5963 per share. $2,842,274
9-Jul-02 HARRELD, J. BRUCE
Senior Vice President
120,000 Sale at $69.086 per share. $8,290,320
29-Jul-02 HARRELD, J. BRUCE
Senior Vice President
120,000 Option Exercise at $23.327 - $31.672 per share. N/A

Source: Insider Trades (Yahoo)

Step in Right Direction, But...

So Sam Palmisano should certainly be commended for having taken this action in the hopes that the executive compensation would be more closely tied in the future to the business performance of the company.  But IBM is not the only major company to have revised its stock option plans under the pressure of public opinion that followed the Enron and WorldCom scandals. General Electric, Microsoft, SAP... are some other companies that have already taken steps in that direction.  Methods have differed but the objective was the same - making the executive suite less sweet was the name of the game.

There is another quandary, however, that neither IBM's latest move, nor those by other major companies, address.  The new rules assume that the future stock rise will a reflection and a result of the management business successes.  But as we have shown on numerous occasions in the last even years, the Wall Street Casino trades on perceptions, not business performance.  The market's ups and downs are driven by investor cash flows, not corporate profits.

So just as Hewlett Packard, for example, found out last week (see "Still No Cigar", Feb 2004), and IBM and many other companies had experienced before that, delivering stellar business results is no guarantee that the company stock will rise.  

In other words, by tying the executive compensation to the stock market, instead of to the business performance, companies are driving their executives in the wrong direction. They are awarding "fluff" (managing Wall Street expectations) instead of substance (see our "fluff ratios" -  "Corporate Cabbage Patch Dolls of the 1990s," Nov 1998, and "King, Prince of 'Fluff' Spin More 'Fluff' into Market", Dec 1999). 

Furthermore, the system is unfair - to the management.  Most corporate executives have no control over their Investor Relations function, whose job is to manage Wall Street expectations, they are being paid on something they cannot personally control.  And that's hardly fair - first and foremost to the executives.

The fact that companies are doing it, however, goes to show us that Wall Street is still wagging corporate tails, even as the boardroom occupants are trying clean up their greedy acts under public pressure.  The recent photographs showing the former Enron CEO (Jeff Skilling) in handcuffs may have been a factor in their mild self-flagellation. 

The change in IBM stock option rules is a step in the right direction, but it is no panacea for the greed-infested market place.  More importantly, it does not address the basic problem - incongruence of business and stock performances.  The modern stock market is a casino, not a corporate scoreboard that it once used to be (see "Wall Street Casino," June 2002, "Wall Street-Main Street Chasm Widens", July 3, 2002), and "The Great American Hoover", Washington Times, Nov 1997).  

As long as the gulf between facts and perceptions remains as wide as it is today on Wall Street, there are bound to be some investors who will cry foul no matter what the stock option rules are.  Or should we call them by their real name - gamblers?  Yet all they need to do is kick the habit.  

Happy bargain hunting!

Bob Djurdjevic

P.S. Some members of the media are continuing to spread fallacies about the former IBM CEO's legacy.  And they are doing by inserting news reporter's opinions into a news story.  To read our e-mail letter to the Times, click here.

For additional Annex Research reports, check out... 

2004: "Still No Cigar" (Feb 2004); "Nokia Dials HP!" (Feb 2004); "CSC: Good Quarter Gets Boos" (Feb 2004); "EDS: Hot Air Jordan" Flaunts Flop as Feat (Feb 2004); "Cronyism Is Alive and Well at EDS" (Jan 2004); "China Now Bigger Than U.S.!" (Jan 26); "IT Industry: Whither Goeth It?" (Jan 26); "IBM: Hype Exceeds Results" (Jan 15); "Five Most and Least Likely Forecasts for 2004" (Jan 2004);

2003 HP: "IBM vs. HP: And the Winner Is..." (Nov 2003); "Strong Finish Not Enough" (Nov 2003) 

2003 IBM: "Small Is Now Big at Big Blue" (Oct 15); "A Passage to India" (July 22),  “On the Nose But No Cigar” (July 16), “A Paler Shade of Blue” (June 2), “Save, Spend and Split” (May 8), “Shrunk by the Marketplace” (Apr 17), “Turnaround Continues...” (Apr 15), “Start of a Real Turnaround?” (Jan 17).

2002 IGS: "Half or Double Trouble?" (Aug. 12, 2002), "IBM to Take $500M Charge" (Sep 3, 2002), IBM-PwCC Update (Oct 2, 2002), Analysis of IBM Second Quarter Results (July 17, 2002), IBM Layoffs Confirmed! (Aug 14, 2002), Analysis of IBM Third Quarter Results (Oct 16, 2002), Boom Amid Gloom and Doom (Oct 10, 2002)

2004: "Hype Exceeds Results" (Jan 15)

2003: "Small Is Now Big at Big Blue" (Oct 15); "A Passage to India" (July 22),  “On the Nose But No Cigar” (July 16), “A Paler Shade of Blue” (June 2), “Save, Spend and Split” (May 8), “Shrunk by the Marketplace” (Apr 17), “Turnaround Continues...” (Apr 15), “Start of a Real Turnaround?” (Jan 17).

2002 IBM: “Gerstner: The Untold Story”  (Dec 27), "Gerstner Spills the Beans" (Dec 13), "On a Wing and a Prayer" (Oct 21), "IBM-PwC Tie the Knot" (Oct 2), "Half or Double Trouble?" (Aug 12), Wall Street/Main Street Chasm (June 25), “Wall Street Casino,” (June 21), Big Blue Salami (June 19), "Looming IBM Layoffs" (May 14), "IBM 5-Yr Forecast: From Here to Eternity?" (Apr 2002),  “Tough Times, Soft Deals,” (Apr 25, 2002), “Gerstner’s Legacy: Good Manager, Poor Entrepreneur” (Jan 2002), IBM Pension Plan Vapors: Where Did $17 Billion Go? (Mar 2002), "Sir Lou OutLayed Lay!" (Apr 1, 2002).

A selection from prior years: Is IBM Cheating on Taxes, Annex Bulletin 99-17 (May 1999),  IBM 5-year Forecast 2001: An Unenviable Legacy (June 2001) "Break Up IBM!" (Mar. 1996), Fortune on IBM (June 15, 2000), “Smoke and Mirrors Galore,” July 2000), "Slam Dunk of Bunk" (Jan 2000), Annex Bulletin 98-14 ("Wag the Big Blue Dog"), Armonk's Fudge Factory (Apr. 9, 1999)Where Armonk Meets Wall Street, Greed Breeds Incest (November 1998)Stock Buybacks Questioned: Is IBM Mortgaging Its Future Again?, 97-18 (4/29/97),  "Some Insiders Cashed In On IBM Stock's Rise, Buybacks" 97-22, 7/27/97,  Djurdjevic’s Forbes column, "Is Big Blue Back?," 6/10/97;  “Executive Suite: How Sweet!,” (July 1997), "Gerstner: Best Years Are Behind", Aug. 10, 1999), "IBM's Best Years Are 3-4 Decades Behind Us" (July 1999), "Lou's Lair vs. Bill's Loft" (June 1999),  "Corporate Cabbage Patch Dolls," 98-39, 10/31/98; Djurdjevic’s Chronicles magazine October 1998 column, "Wall Street Boom; Main Street Doom", “Louis XIX of Armonk,” (Aug. 1996), "Mountain Shook, Mouse Was Born" (Mar. 25, 1994), “A Nice Guy Who Lost His Compass” (Jan 26, 1993), “Akers: The Last Emperor?” June 1991), Industry Stratification Trend (Mar. 30, 1990) etc.]

Or just click on and use "financial engineering" or similar  keywords.

Volume XX, Annex Newsflash 2004-05
February 25, 2004

Bob Djurdjevic, Editor
(c) Copyright 2004 by Annex Research, Inc. All rights reserved.
e-mail: annex@djurdjevic.com

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