The Nuclear Option for Dolby Labs

In the wake of the options- backdating scandal that deposed the CEO of UnitedHealth Group and sent the CEO of Brocade Communications to jail, the lie was exposed that stock options align the interests of management and shareholders.

Although the clamor and rancor of repricing options died down, the problem hasn't gone away. Companies continue to bail out executives and employees whose options are underwater, and sound specialist Dolby Labs (NYSE: DLB  ) is only the latest to try its hand at giving them a mulligan.

It's an option, not a guarantee
Stock options give the holder the right to buy a stock at a certain price -- called the "exercise" or "strike" price -- at some point in the future. The theory is that options are an incentive to have management (and employees) work hard to ensure that the company's value increases, and as its share price grows, management and shareholders can profit together in its future.

The backdating and repricing schemes reveal that companies don't look at options as an opportunity, but rather as a guarantee of profit. Where common shareholders bear the full cost of any decline in a stock's price, executives and employees want to bear none of the cost. They want to profit no matter how the company performs.

Fine young cannibals
With the iPad cannibalizing computer sales in 2011, and with the threat that Microsoft (Nasdaq: MSFT  ) will cut Dolby from its Windows operating system, the value of the sound specialist's stock was cut in half. That's left some 82% of all its options (and 96% of unvested employee options) underwater, and it wants to exchange them for a lesser number of restricted stock units to restart the clock and give everyone time to profit.

No doubt Dolby's plan is better than most other schemes and in fact conforms to many of the principles the good corporate governance folks at Risk Metrics Group advocate:

  • The plan should first receive shareholder approval.
  • It should minimize the number of shares subject to replacement awards.
  • The exchange should occur at least 12 months after the stock's decline in value.
  • Only stock options that were granted at least two years before the exchange should be eligible for the exchange.
  • The value of the consideration received in the exchange should be no greater than the value of the surrendered stock options.

But Dolby ignored other areas, such as excluding senior management. Considering that they have millions of options underwater, it's likely the exchange program is being done primarily for their benefit as much as for the employees.

Yet outside investors don't get a do-over. Dolby's employees prospered when the company was raking in millions in licensing revenues from Microsoft almost without having to do anything. As long as PCs were selling, the stock price soared. So if the options rewarded them for circumstances for which they had nothing to do, why shouldn't they bear the burden like everyone else when the decline is also beyond their control?

Apologists for companies caught up in the tangle readily dismiss the issue as little more than an accounting-definition hubbub. Indeed, Apple (Nasdaq: AAPL  ) shareholders in particular were willing to forgive Saint Steve when he was found to have been in the middle of a backdating options scandal. Yet Apple's stock, which traded at well under $100 when it fudged the options dates, now trades for more than $400 a stub.

Now hear this!
As a Dolby shareholder, I plan to vote "No" on the proxy proposal. While there are good reasons for getting rid of the overhang associated with the options -- the accounting charges, for example, that companies have to record even though the options will probably never get exercised -- it doesn't change the fact the exchange gives everyone but regular shareholders who are nursing the hurt of an "underwater" stock price a second bite at the apple.

Dolby's management generally acts with shareholders' interest at heart, and even the current scheme is better than most. But management and employees should bear impact of a changed business environment just as much as outside investors do. There's no need to use the nuclear option to benefit one group over the other.

Is this much ado about nothing? Will you also vote "No" on your proxy ballot? Let us know in the comments section below.

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Add Dolby Labs to the Fool's free portfolio tracker, which can find all of our Foolish analysis on it and all your other stocks.

Fool contributor Rich Duprey owns shares of Dolby Laboratories, but he holds no other position in any company mentioned. Check out his holdings and a short bio. The Motley Fool owns shares of Apple, Amazon.com, and Microsoft. Motley Fool newsletter services have recommended buying shares of Amazon.com, Dell, Goldman Sachs, Apple, Microsoft, Dolby Laboratories, and Netflix and creating a bull call spread position in Apple and Microsoft. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


Read/Post Comments (13) | Recommend This Article (20)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On January 03, 2012, at 5:59 PM, rajeshbella wrote:

    Yes. I will vote "NO". I agree with the main point of this article. So what would be the benefit to the average shareholder for allowing the proposal to go forward? Psychological?

  • Report this Comment On January 03, 2012, at 8:44 PM, susantwentyeight wrote:

    This whole pushing-reality-onto-the-shoulders-of-those-who-didn't-create-it thing is becoming a global phenomenon..

    This totally defeats the purpose of options as you said Rich.. thanks for the heads-up.. i'll vote No if i hold the stock long enough.. they gonna use me as market-fodder i might hafta use them as a short-term loss!

  • Report this Comment On January 04, 2012, at 2:27 AM, militauro wrote:

    Also a guaranteed "No" vote here.

    I've taken losses on options granted before and not particularly fond of anything that walks and smells like a bailout.

  • Report this Comment On January 04, 2012, at 10:06 AM, Fordstito wrote:

    Not only did I vote no on the proxy, I also withheld approval for Kevin Yeaman, the CEO. As though it makes a difference! oh well, maybe somebody at Dolby will get the message.

    "If voting could change things, elections would be illegal."

  • Report this Comment On January 04, 2012, at 11:07 AM, noelski8020 wrote:

    I will vote "NO" also.

  • Report this Comment On January 04, 2012, at 12:08 PM, zberk wrote:

    Voting "no". Management rewards for losses makes no sense. Thanks for this article. Hopefully it raises awareness.

  • Report this Comment On January 04, 2012, at 2:13 PM, dokworks wrote:

    Ray Dolby and family have like 90% of the voting power. While I disagree with this, our votes have no weight. Plus, the issue isn't really very serious.

  • Report this Comment On January 04, 2012, at 4:48 PM, TMFCop wrote:

    dokworks,

    You're absolutely right and I should have mentioned it in the article, but I disagree it isn't really serious. No, it's not going to bring Dolby to its knees, but shareholders acquiescing every time management misuses shareholder resources (I'm talking about companies in general, not necessarily Dolby) has allowed them to think they can rewrite the rules of the game with impunity.

    Most of the time common outside shareholders won't be able to influence a vote; institutions and insiders typically control most of the votes. In Dolby's case it's just more so.

    But you have a vote and should vote your conscience or you're just wasting it. I certainly won't put my imprimatur on a practice I don't agree with. They'll likely pass it -- what the Dolby's want the Dolby's will get -- but they'll do so without my help.

    Rich

  • Report this Comment On January 04, 2012, at 4:57 PM, TMFTomGardner wrote:

    This problem is completely remedied by using restricted stock rather than options. I think a more powerful message than just a vote is a call into the company to let them know that options granting is ineffective, as just proven. They should scrap this plan and simply issue a smaller number of restricted shares. - Tom Gardner

  • Report this Comment On January 05, 2012, at 12:07 AM, majakblue wrote:

    I'm voting no also. It may not make a difference since I only have a few shares of Dolby stock, but maybe it will get the Board's attention.

  • Report this Comment On January 05, 2012, at 12:31 PM, thenewt wrote:

    I appreciate hearing the Fool weigh in on a proxy vote question. Let's hear more articles like this.

    I plan to vote "No."

  • Report this Comment On January 07, 2012, at 2:43 AM, Rowants wrote:

    Something told me to dump this stock at $50 not too long ago. I should have listened to that little voice. But noooooo, I just had to think that dip to $48 was a dip, and the stock would bounce back.

  • Report this Comment On January 09, 2012, at 11:43 PM, 123spot wrote:

    I won't vote no with my measly shares, but I will sell. Really the best vote. Sad though, because I trusted the old school. Spot

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