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Steve Jobs And The Options Grants

by | 6th, October 2011

SO Steve Jobs is dead: long live Steve Jobs.

There are of course acres of newsprint devoted to him today but for me two little stories stand out.

It was only a couple of months ago that his biological father (Jobs was adopted) was revealed to still be working in a Nevada casino and that the two of them had never met or even talked on the phone as adults. I wonder if they did in these last couple of months?

The second is a minor financial story and given that this is the money column, an annoying little detail it’s worth correcting. It’s about backdated options grants. In his Telegraph obituary:

In 2001 he was granted stock options amounting to 7.5 million Apple shares, allegedly without the required authorisation from the company’s board of directors. Furthermore, the option came with an exercise price of $18.30.

But this price allegedly should have been $21.10, thereby incurring a taxable charge of $20 million that Jobs did not report as income.

There was a little spate of this going on in tech companies at the time and it became a minor scandal. However, it’s almost universally misunderstood.

An option is the right to buy a share (OK, a stock option is) at a price determined today at some point in the future. So, if the shares go up, the managers get to make the profit on those shares going up. Shrug.

You can issue an option at absolutely any price you want. If today’s stock price is $21,10 you can issue options at $40: the managers only make money if the share price goes over $40 by the date they’re allowed to exercise their options.

You can also issue options at $0.01 if you like: the managers are therefore sitting on a hefty profit already. What was being done: umm, OK, what was being rumoured to be done, was that the people issuing options would decide upon, say, Wednesday, to issue options. But they’d look around at the share price for the past few weeks and if, say, last Thursday, the price had been $18.30, they would issue the options at $18,30.

Yes, this matters, this is what the backdating part of it was about. For, if you issue an option at the actual share price, then the manager has received no income now: they’re only getting money a few years down the line when they exercise. So no tax is payable. If the options are issued at below today’s price, then they’ve made an income which they must pay tax on. As reported by the Telegraph of course: fiddling about with the supposed date of issue makes the difference.

However, it’s not actually the income tax, the tax that the managers should pay, which is the problem. It’s the company accounting on the other side which is. For if options are issued at today’s price, then as the manager hasn’t received any money nor has the company spent any (you know, accounts have to balance? For every debit there’s a credit?). So no money gets knocked off the company profits to be the matching debit for the credit to the manager’s pay packet.

But, if the options are in the money, if they’re issued at $18.30 instead of $21.10, the manager has received $20 million: which means that you’ve then got to go and knock $20 million off the company’s reported profits. Which this backdating of options covered up.

And that was really the naughty bit. Nothing to do with playing with the price of options: you can issue them at any price you like. Not Steve Jobs and his income tax, the real problem was fiddling the company profit numbers.

The great irony of all this is that if the options had been properly granted, properly accounted for, Jobs would have made over $2 billion: lost for the sake of trying to save $20 million on the company books.



Posted: 6th, October 2011 | In: Key Posts, Money Comment | Follow the Comments on our RSS feed: RSS 2.0 | TrackBack | Permalink