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Barel Karsan
Barel Karsan

hhgregg Management Rips Off Shareholders

May 06, 2013 | About:

hhgregg (HGG) has always struck me as a rather shareholder-friendly company. So it caught me off-guard when hhgregg's management decided to re-price its underwater options. Such actions are a huge red flag for investors.

The handout of options to managers is always justified on the premise that it aligns manager and shareholder interests. What is often glossed over, however, is the fact that options contain an inherent asymmetry in their outcomes: a poor outcome, even an extremely poor one, results in option values that never go below zero, whereas a positive outcome results in positive gains. Because of this asymmetry, managers who are paid in options are incentivized to take far more risks than shareholders would deem appropriate. This is no small issue; as I've written before, the use of options likely contributed to the downfall of Lehman Brothers.

So even left untouched, options already provide perverse incentives to management. But by re-pricing options, as hhgregg just finished doing, the incentives become even worse. Rather than option values that go to zero when the stock price gets pummeled, management actually gets long-term benefits from a felled stock price! For example, CEO Dennis May just saw the strike price on 75,000 of his options go from $28.31 to just $13.56!

The explanation offered up by the company is that these strike price reductions were accompanied by a three-year increase in vesting periods, encouraging employee retention. But that sounds like a lame excuse; by providing even more time before the options expire, the options become even more valuable. For example, in the Dennis May example cited above, his options went from being worth 7 cents each to being worth over $3.50/option! (Calculations are based on this Black-Scholes option value calculator.)

Instead of expiring in 2017, his options will instead expire in 2020. Did shareholders really benefit from this extra vesting period? Probably not, I would venture.

The strange thing is, this company has otherwise behaved in a rather shareholder-friendly manner. Management owns a considerable number of shares, only grows when it is profitable to do so, and buys back shares when the stock is cheap. But this option re-pricing appears nothing more than a cash grab. Going forward, this company should be closely monitored for more unscrupulous activity.

Disclosure: Author has a long position in shares of HGG

About the author:

Barel Karsan
Charlie Tian, Ph.D. - Founder of GuruFocus. You can now order his book Invest Like a Guru on Amazon.

Rating: 3.3/5 (3 votes)



BEL-AIR - 4 years ago    Report SPAM
I love this company...

Good detective work though...

I agree with you that this really sucks and is not the best...

However Dennis May still owns more than 10% of the shares, so he still has a massive interest of what the stock price does.

33,4000,000 million outstanding shares, I guess other share holders were like partly robbed for 70,000 shares. It is not that big compared to the total amount but still matters.

Buffett once complained to Munger on the options and wages management got in the companies he was looking at... What did he do?

He still bought the common stock on alot of these since good idea's and business are hard to come buy and undervalued ones are even harder to come by..

This is just how it is done...

I agree I don't like it, bit just look at the wages all the ceo's make for example

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