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Standing and Prosecutorial Discretion: Why the Doctrine of Standing Precludes Challenges to Categorical Non-Enforcement
Get PDF11th Hour Option Discounting: The Significance of IPO Prognostications in Fixing Equity Compensation
Get PDFThis article examines the pervasive practice by pre-IPO firms of granting stock options as compensation while preparing to go public. These last-minute option grants, which are typically not contingent upon initial public offering (IPO) completion, feature substantially lower exercise prices relative to the IPO price, thus producing a windfall potential to executives and other option recipients once these firms consummate their IPOs shortly after having made these discounted option awards. I present empirical evidence to the effect that this 11th hour option discounting practice is common. I scrutinized the option grant practices of a hand-collected dataset comprising U.S. preclinical and clinical-stage biotechnology companies that pursued initial public offerings of common stock on a national stock exchange via registration on Form S-1 during the period from 2017 through 2021. The data I collected was derived from securities filings as well as correspondence by these pre-IPO firms with the Securities and Exchange Commission (SEC), including as a result of Freedom of Information Act requests.
The difference between the exercise prices of options awarded near the IPO and the IPO price at which firms offered their shares to the public shortly after making these option grants was substantial. Option holders enjoyed median and equal-weighted average discounts of forty-eight percent and forty-seven percent on the IPO price for 147 discounted option grants made during IPO preparations, with a weighted average of forty-eight percent. Almost half of these discounted options were awarded within forty-five days prior to the first day of public trading. These lastminute discounted option awards were sizable. When aggregating the shares of common stock underlying the discounted option grants during IPO preparation with the shares of common stock offered by these firms in their IPOs, the total shares of stock underlying these option awards represented, on average, eight percent of the total combined offering per firm, with a median of six percent. Albeit the pre-IPO firms allowed option recipients to effectively purchase eight percent of the total shares at a deep discount relative to the price at which they then offered the other ninety-two percent to the public, thus depriving firms of needed capital while significantly diluting IPO investors.
All of the firms in this study were emerging growth companies. At the time of their IPO, their business model was still unproven. All had accumulated a deficit and virtually none of them were profitable. They went public to raise capital in order to advance their therapeutic candidates through clinical trials. As a result, IPO investors would expect that the equity compensation awarded to corporate insiders—the chief executive officer, other corporate officers, and the board of directors—as well as other key employees incentivized them to grow their firm’s equity value post-IPO. Yet, corporate insiders received sizable equity awards at deep discounts on the IPO price just before their firms went public. For example, more than three-quarters (78%) of the firms in this study that granted discounted stock options during IPO preparation awarded heavily discounted options to corporate insiders, who, collectively, captured an average potential windfall of 2.6 million. Firms routinely asserted in their securities filings and in their correspondence with the SEC that these option grants made in close proximity to their upcoming IPO were “at-the-money” even though the fair value they assigned to the underlying stock was substantially lower than the price at which they would offer shares to the public shortly after option grant. The average and median increases between option exercise price and IPO price were 124% and ninety-two percent.
Current regulatory and accounting rules incentivize firms to keep the fair value of the stock underlying their last-minute option grants low to reduce option expenses, thus improving corporate earnings or reducing corporate losses. Option recipients are highly motivated to receive options with an exercise price equal to a low fair value of the underlying stock to avoid adverse tax consequences and benefit from a future windfall potential. The practice of 11th hour discounting is facilitated by glaring weaknesses in the regulatory framework. Pre-IPO firms exploit a seemingly quantitative stock valuation technique, the Probability-Weighted Expected Return Method. They conjure up exceedingly pessimistic prognostications as to IPO outcome which allow them to set option exercise prices well below the price at which they sell shares to investors in their upcoming IPO. Pre-IPO firms often make incomplete and arguably misleading disclosures regarding their last-minute discounted option grants in their registration statements. Discounted awards made to corporate insiders during IPO preparations are often obscured.
Prospective IPO investors expect pre-IPO firms to take measures during their IPO preparations to align the interests of management and employees with the interests of their new investors in the forthcoming IPO as these firms rapidly transition to public company status. I propose regulatory improvements to address 11th hour option discounting in order to correct the misalignment created by this practice and to ensure corporate insiders and their subordinates are incentivized to grow firm value post-IPO
The U.S. Forced Labor Import Ban: A Tool for Raising Labor Standards in Supply Chains?
Get PDFForced labor is rampant across global supply chains. Addressing it at individual sites of production results in a game of whack-a-mole. An effective response must target the structural drivers of the problem: the large firms at the top and middle of supply chains that pressure suppliers at the bottom to cut labor costs in order to remain competitive. In the absence of other U.S. laws that address the structural causes of forced labor, this Article argues that the forced labor import ban in section 307 of the United States Tariff Act may have the potential to be utilized by civil society organizations and the State in top-down ways to hold lead firms at the top and middle of supply chains accountable for facilitating forced labor. Additionally, it may offer a resource to bottom-up efforts by workers in supply chains and the unions that represent them to demand that both brands and suppliers take responsibility for improving working conditions.
This Article makes three contributions. First, it contends that although enforcement of section 307 to date has been sporadic and often influenced by foreign policy concerns, the U.S. government possesses the legal authority under existing statutes and regulations to target enforcement in ways that address the structural drivers of forced labor both from the top down and the bottom up. Second, it offers the only account to date of how civil society actors have used the law’s public petition mechanism and other interventions in efforts to direct government resources towards a systemic enforcement approach. Drawing on interviews with key civil society and government actors and a review of both confidential and public petitions, this Article maps advocates’ strategies and the government’s response, illustrating the government’s resistance to enforcing section 307 against lead firms at the top of supply chains and its partial openness to a structural enforcement approach at the middle and bottom. Third, it highlights the urgency of solutions to forced labor that support the exercise of freedom of association by supply chain workers. Here, it proposes a novel way for unions to draw on section 307 as leverage when they organize in supply chain contexts