The Pain of Zynga's Brain Drain

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Holy brain drain! At least eight high-profile executives have departed Zynga (Nasdaq: ZNGA  ) in the past six weeks. The consensus explanation for why: With shares down 79% since March, stock options awarded as compensation are deeply underwater. As goes the pay, so go the executives.

I'm not convinced it's that simple. It's easy to chalk the exodus up to an unfortunate stumble of the share price -- something else to blame Wall Street for -- but there's probably more going on here.

The list of companies whose stock prices plunged without a mass management resignation is a long one. Microsoft (Nasdaq: MSFT  ) shares fell 60% in 2000 after the dot-com bubble burst. Did executives run? Not really. A local headhunter told the Associated Press that year that "There really hasn't been an increase in the people leaving Microsoft." Google (Nasdaq: GOOG  ) shares plunged 65% during the financial crisis, but it didn't seem to have much effect. Former CEO Eric Schmidt told The New York Times two years ago that the company's attrition rate for people it wanted to keep had been stable for seven years, and 80% of employees offered a job at another company turned it down after Google made a counteroffer.

So, what's Zynga's problem?

In 2008, a group of business professors from Purdue, Indiana University, and USC looked at executive compensation at big U.S. companies from 1996 to 2006. They discovered that, sure enough, "the degree to which executives' stock options were underwater was positively related to voluntary turnover." When stocks plunged, they quit.

But there's a catch. Another study by two business professors from Wharton and the University of Virginia shows that companies offering to reprice executives' underwater stock options -- effectively reversing losses from underwater options -- had no measurable impact on departing executives' decision to leave.

So, executives tend to quit when their options plunge in value. But being offered the opportunity to reverse those losses doesn't tend to persuade them to stay. They're leaving for reasons beyond compensation.

What that shows, I think, is important.

Stocks plunge for one of two reasons. Either they were irrationally overvalued, or the actual business is in an upheaval. In the former, the business can grow and succeed and meet its goals, but the stock still falls. That's what happened to Microsoft and Google last decade -- both grew earnings and revenue by big amounts while their shares wept. In alternative scenario, the company's business model is being called into question. That's what's happening to Zynga. Zynga's stock isn't in the tank just because it was overvalued. It's in the tank because of the possibility that buying virtual farm animals is a passing fad.

If you're an executive, that matters. Executives -- particularly those from the Silicon Valley startup crowd -- tend to be motivated by something beyond pay. They want to be part of the next big thing, breaking ground into new territory and changing the world. If they really believe in what they're doing, they'll tend to stick around even when the company's stock, and their pay, falls. When they lose faith in the company's future, they tend to move on regardless of pay.

Bottom line: Zynga executives may not be leaving because the stock plunged. They may be leaving because they -- and the market -- are losing faith in the company, which also happens to be causing the stock to plunge. It's a slight, but important, distinction.

Fool contributor Morgan Housel owns shares of Microsoft. Follow him on Twitter, @TMFHousel. The Motley Fool owns shares of Google and Microsoft. Motley Fool newsletter services have recommended buying shares of Microsoft and Google and creating a synthetic covered call position in Microsoft. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days. The Motley Fool has a disclosure policy.

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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 September 20, 2012, at 10:42 AM, TMFNewCow wrote:

    Nice headline, Fool.

    -- Evan

  • Report this Comment On September 21, 2012, at 7:55 PM, wannalivelife wrote:

    Before they went public, Zynga made headlines for forcing a lot of their employees to surrender their stock options. When they were not as hot, they offered a lot of stock as compensation to hire the talent and when the company seemed to be in a good shape IPO-wise, Pincus apparently felt that a number of Zynga employees were to become rich without really deserving it. With practices like that, I am not surprised that people would not think twice when going has turned absolutely sour. Moral of the story is that "talent" likes to be treated as talent and not as pawns.

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