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Allan Sloan

Stock-Options Rule, Merck, AOL Ads: The Top Turkeys

By Allan Sloan
Tuesday, November 23, 2004; Page E03

With Thanksgiving just around the corner, what better time to talk about turkeys? Of the business variety, of course. You know, the kind of foul-up that makes you say, "Wow, that idea was a real turkey." Normally, a single candidate stands head-and-drumstick above the flock. But this year three candidates -- involving math, medicine and marketing -- are so strong that picking one is like choosing among roast turkey, turkey gravy and turkey sandwiches. They're all wonderful in their own way; the one you like best depends on your particular taste.

Let's start with the math turkey, which involves stock options. Thanks to an accounting loophole, companies can avoid counting the value of the options they grant as an expense, but get tax deductions when employees cash them in. They're a corporate free lunch. When Enron, symbol of the options culture run amok, collapsed three years ago, it seemed only a matter of time until regulators succeeded in their 15-year campaign to force companies to treat options as an expense. After Enron, many companies -- including The Washington Post Co. -- began expensing options voluntarily. But corporate hard cases and their congressional allies recently got the Financial Accounting Standards Board to delay options-expensing for six months. Which may turn into forever.

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The opponents' main argument -- that an option isn't worth anything because it's granted at the stock's market price -- is totally bogus. As witness, the fact that J.P. Morgan last year paid Microsoft employees $400 million for "underwater" options, whose exercise price was above Microsoft's stock price. Morgan is now offering up to $125 million for Comcast options, 75 percent of them underwater, that AT&T employees got when Comcast bought AT&T's cable-TV business. If employees' underwater options are valuable, options they get at the market price are even more valuable.

And consider the Michael Ovitz trial. Ovitz's much-ballyhooed $140 million severance package from Disney actually consists of $39 million in cash and options on 3 million Disney shares. The shares were selling for about $42 million more than the options' exercise price when Ovitz was ousted from Mouse Central in 1996. Everyone agrees the options were worth more than $42 million, although the defense doesn't buy the plaintiffs' $101.5 million valuation.

These real-world examples probably won't disturb the pols beating up accounting regulators. Maybe the next options-related scandal will change things.

Our second turkey award goes to Merck, for the way it decided to withdraw its Vioxx anti-inflammatory drug last month. Merck had indications of possible heart-related problems with Vioxx almost from the time it started selling it in 1999. But it kept advertising Vioxx to the public while running new tests to make sure it was safe. When tests conclusively showed problems in September, Merck had a chance to keep selling Vioxx with additional warnings. Instead, seeking a good-guy mantle, it pulled the pills. As almost anyone outside Merck could have foreseen, that left the company open to the financial, legal and regulatory turmoil that now threatens to destroy it. Merck says it pulled Vioxx rather than adopting stronger warnings because it's run on best-practice medical principles rather than by legal or marketing parameters. But it's hard to reconcile that with peddling Vioxx to the public. Pulling Vioxx is noble -- but it's a tacit admission the medicine has hurt people. Hanging tough, while restricting Vioxx to people like me who can't tolerate standard anti-inflammatories, would have been a better legal and strategic choice.

And now, our final turkey goes to the America Online ad campaign. That's the one that showed lines of customers outside AOL offices, with the company granting their demands for a better Internet. To me, the ads might as well have said, "Our customers know we ignore them, so we'll show how much we value them." It's like Fox News calling itself "fair and balanced" when it knows so many people consider it to be neither. AOL says it was showing people unhappy with the Internet, not with AOL. But that's not how people outside AOL would view it. It's certainly not how I saw it.

What ties these turkeys together is that they're examples of ignoring the obvious. If options are worthless when they're granted, why do employees want them? If Merck cares only about medicine, why did it keep advertising Vioxx after early indications of possible trouble? Did AOL show those ads to anyone outside the company?

Contemplate these questions as you chow down on your turkey. Gobble, gobble, gobble.

David J. Jefferson in Los Angeles contributed to this column. Sloan is Newsweek's Wall Street editor. His e-mail address is sloan@panix.com.


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