Are EA Executives Too Focused on Stock Price?

Electronic Arts (NASDAQ: EA  ) executives are being accused not only of misrepresenting the company's fortunes and boosting the stock price, but also of selling thousands of shares after the boost.

Two law firms – Robbins Geller Rudman Dowd and Bower Piven – are currently trawling for lead plaintiffs in class action lawsuits that accuse EA executives of making "materially false and misleading statements." The statements that are in doubt relate to executives raising expectations about EA's Battlefield game release while knowing that it was riddled with bugs.

The stock began to climb in May last year from $17.30 to a high of about $28 in September then, as news of the bugs began to leak out, the stock fell back to about $21 in December.

Guilty or not...

We don't know whether the accusations against the executives are true, but even the suspicion made me want to know if there was anything about the way they were paid that might cause them to behave in that way. It does usually come down to pay. So I checked into EA's latest proxy statement from June last year, the most recent one available.

At that point, the company had recently let go its CEO, John Riccitiello, with a very generous golden parachute. The new CEO, Andrew Wilson, was promoted in September last year, right in the teeth of this controversy. He was awarded a million stock options in September – not such a great deal because the stock has not recovered to that price since. But it's not Wilson's golden hello that is interesting.

A single-minded focus

Any kind of temptation to manipulate a company's stock price generally comes from executives' overexposure to such stock price in their compensation. And that happens to be true at EA.

Executives are awarded restricted stock units (RSUs) that vest over time; stock price-performance RSUs that vest according to the company's Total Stockholder Return (TSR = stock price plus dividends) against the Nasdaq 100 stock price; and even the annual cash bonus, while based on other metrics as well, is also adjusted based on TSR vs. Nasdaq 100 stock price again. In my opinion, that's too much pay based on a single metric.

But wait, I hear detractors say, isn't that the case with most senior executives, especially in the gaming industry? So I checked a couple of EA's competitors – competitors it names in its own compensation report. I looked at Take-Two Interactive  (NASDAQ: TTWO  )  first. It also awards RSUs but bases them not just on TSR but also on EBITDA (earnings before interest, taxes, depreciation, and amortization) making it more difficult to game performance on stock price alone.

Then I checked Activision Blizzard (NASDAQ: ATVI  ) and its stock awards are based on EPS, free cash flow, and relative TSR, again making it difficult to earn awards simply by manipulating stock price.

Of course, if it turns out to be true that EA executives made misleading statements, surely the board can take back stock awards that may have been earned based on an inflated stock price. Most companies now have such arrangements in place. And indeed, EA also has such a policy, known in the trade as clawbacks.

Unfortunately, stock awards are only recouped under this policy if fraud or other misconduct causes the company to restate its financial statements. And that is unlikely in this instance.

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