Legalized Embezzlement

"I’ll have a double espresso, please," your editor asked
the pimply-faced teenager behind the counter of a Starbucks
outlet near Denver, Colorado.

The teen looked puzzled, so your editor repeated the order,
"A double espresso…You guys call it a doppio…See, it’s
on your sign back there."

"Um, okay," the teen replied, as he walked over to confer
with a fellow employee. The two of them huddled over some
sort of Starbucks handbook.  After flipping through several
pages of the book, they found the one they were seeking.
They studied it for about 30 seconds. Finally, one of them
raised his eyes from the handbook, turned to your editor
and asked, "So it’s just two shots of espresso, right?…Is
that all?"

"Yes," your editor chuckled, "That’s all…I’m just
curious; is this the first time anyone has ever ordered a
double espresso?"

"Yep," they replied in unison. "No one ever asked for one
of those."

"What about a single espresso?"

"No, never got an order for one of those either."

"That’s kinda funny," your editor continued. "How long have
you worked here?"

"About one month," came the reply. "We just don’t get
orders like yours."

An espresso bar that rarely sells an espresso may represent
a kind of aesthetic tragedy, but it is a capitalistic
triumph. Just ask Starbucks’ shareholders. An espresso-
filled porcelain demitasse, garnished with a lemon twist,
may delight coffee purists, but it irks coffee capitalists.
There is no money to be made selling cheap espressos in
cups you have to wash and re-use.

Gaudy, 20-oz. coffee-based creations, slathered in whipped
cream and caramel syrup, and served in throwaway plastic
cups, produce much higher profit margins. It is no
accident, therefore, that the world’s most successful
espresso company sells very few actual espressos. Thanks to
corporate innovations like the Venti Green Tea Frappuccino,
the Starbucks Company has rewarded its shareholders
handsomely over the years.

Unfortunately, many other U.S. corporate innovations – like
the executive stock-option grant, for example – have abused
the very shareholders they purport to benefit.

Innumerable American corporations have lavished option
grants on their top executives, in the process establishing
a kind of legalized, systematic embezzlement. Because these
"incentive" bonuses divert corporate wealth toward company
officers, they divert corporate wealth AWAY from the
minority shareholders. A small diversion wouldn’t be so
bad. But the diversions are anything but small. In some
extreme cases, option grants claimed more than 40% of a
company’s market value. Overall, this so-called "overhang"
still represents more than 15% of the market value of the
S&P 500 companies, according to the Investor Responsibility
Research Center.

Worse still, the economic cost of these grants has rarely
appeared on a corporate income statement. Until very
recently, companies routinely buried the cost of option
grants in the fine print of their SEC filings. And almost
no company would deduct the true cost of option grants from
their reported earnings. And because most companies have
not been concealing these costs, they have been overstating
their true profitability.

Last year, for example, the S&P 500’s "operating earnings,"
the flattering, quasi-fictional results imagined by Wall
Street analysts, totaled $66.62. But after applying GAAP
standards to these quasi-fictional earnings, and adjusting
them for the cost of stock options, the S&P’s actual
earnings dropped to only $55.25, according to James
Montier, equity strategist at Dresdner Kleinwort
Wasserstein. That earnings number would put the S&P 500 on
a rich PE multiple of 22 times earnings.

Happily for us minority shareholders, the years of
legalized embezzlement are drawing to a close.

Increasingly, as the chart above illustrates, shareholders
are voting to reject corporate stock option programs. In
1988, for example, less than 5% of all stock option plans
received a "nay" vote. But that percentage hit nearly 25%
last year.

Stock option plans have not yet become as rare as a
Starbucks double espresso…but they should be.

Did You Notice…?
By Joel Bowman

For those of you who enjoy the, somewhat peculiar, benefits
of subterranean living and did not hear the news over the
weekend, here it is: Vancouver played host to the Agora
Wealth Symposium – a gathering of some of the brightest
minds in the world of finance today.

Monica Day, our embedded reporter, was busy quaffing wine,
toasting the success of Addison’s new book, The Demise of
the Dollar and, oh yes, delivering all the news from behind
the scenes to Daily Reckoning readers.

She also managed to enlighten a larger-than-expected number
of savvy, wealth enthusiasts with a very special
offer…one that will end at midnight tonight. More on this
in just a moment. First, a few of the highlights.

A plethora of finance experts and analysts, countless
rounds of ‘extra guru’ beer, the voice of God and finally,
finally Harry Potter is dethroned from the #1
position. The Agora Wealth Symposium was an event to

Bill Bonner addressed the looming debt problem in America
with insight and unmatched anecdotal aptitude. Readers of
the Daily Reckoning have come to expect nothing less from
the founder and CEO of Agora, Inc.

Presentations from Dr. Steve Sjuggerud, President of Oxford
Club’s Investment University, Kevin Kerr, The resource
trader dubbed the ‘Maniac Trader’ and Carl Waynberg, editor
of Penny Stock Fortunes and The GRIP, were all part of
three electric days of investing ingenuity.

But back to Monica’s offer and tonight’s deadline. Anyone
who missed out on attending last weekends presentations and
festivities need not fear. All you need to know and wished
you heard over the weekend has been captured on a
collection of CD’s.

After Midnight tonight, the price of this collection will
jump and, if the weekend’s order quantities are anything to
go by, first editions may be all gone – Perhaps we should
have had our market analysts predict the number of copies
that would be sold rather than our marketing team!

And the Markets…



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