San Francisco – Silicon Valley business leaders have long served on one another’s boards, giving bright minds a way to share their collective wisdom and fostering a climate of corporate clubbiness that prizes personal networks as much as computer networks.
But what happens when bad ideas seep into chummy boardrooms? An answer may be emerging as federal prosecutors and regulators dig deeper into a stock-options scandal that has forced dozens of companies across the country to wipe out more than $5 billion in combined profits.
At least 28 of the northern California companies nursing stock-options headaches share a common director with one other company wrestling a similar problem, according to a recent analysis that blames the close relationships for spreading the accounting shenanigans like a nasty virus.
“The theory behind social networks would seem to suggest very strongly indeed that these interconnected boards have something do with stock option (manipulation),” said Paul Hodgson, who co-wrote the study for the Corporate Library, a shareholder watchdog group.
Most of the trouble revolves around the “backdating” of employee stock options without properly accounting for the maneuver – a deception that can boost profits and lower taxes. Backdating refers to options that are issued retroactively to coincide with low points in a company’s share price to increase the recipient’s potential windfall.
The practice isn’t necessarily illegal as long as the backdated stock options are properly recorded on the company books. If the accounting for the rewards is bungled, it can exaggerate corporate profits and improperly lower taxes.
Even more earnings could evaporate in the months ahead because not all the companies with potential stock-option trouble have calculated the financial damage.
More than 160 companies nationwide have disclosed that their stock-option practices are under internal review or being investigated by the government. At least 51 of those companies, including the 28 in northern California, shared common directors, according to the Corporate Library.
So far, there’s no concrete evidence to tie Silicon Valley’s stock- option chicanery to the circle of directors who sat on common boards. But the Securities and Exchange Commission is examining the role directors played in the scandal.
“It wouldn’t be a surprise if knowledge like this got passed along among executives and had a cascading effect through the community,” said James Post, a Boston University professor specializing in corporate governance and business ethics. “Just as networks pass along good ideas, they can play a critical role in passing along bad ideas too.”
The confluence of friendly CEOs in Silicon Valley boardrooms is a longtime peeve of corporate governance experts, who believe the amiable atmosphere makes directors less likely to detect and crack down on abuses such as backdating stock options.
“Silicon Valley has always had a very cavalier attitude toward corporate governance,” said Charles Elson, director of the Weinberg Center for Corporate Governance at the University of Delaware. Conflicts of interest are even more likely to arise among directors when CEOs agree to serve on one another’s boards, he said.
The overlap “creates independence issues, and it challenges a director’s ability to remain objective,” Elson said. “You can be the smartest person in the world and not be objective. Shareholders need people who are objective on the board.”
