By MICHELLE QUAH

 

MEDICAL equipment maker LMA International reported lower third quarter earnings yesterday; but its troubles go farther back than that. The past fortnight or so has been a tough one for the company, since it revised its guidance for its FY2007 financial performance.

 

After the company announced on Oct 11 that its net income for the current financial year will fall - instead of increase, as earlier expected - from the previous year, its stock has shed about a third of its value and analysts have cut their price targets and downgraded the counter.

Closing at 43 cents yesterday, LMA shares have lost 24 per cent of their value - or 13.5 cents - since their close of 56.5 cents on Oct 11. JPMorgan has since reduced the company's rating from overweight to underweight and cut its price target from 68 cents to 37 cents, while Credit Suisse has downgraded the stock from neutral to underperform and lowered its price target from 59 cents to 45 cents.

This dismal stock price performance brings to mind LMA's generous executive share option plan - which, as an incentive reward scheme, now seems at odds with its share performance.

Potential dilution

The Singapore-listed, Dutch company - known best for its LMA laryngeal mask, which provides airway support to patients during surgery - has one of the more generous employee stock option schemes here.

Since its adoption in 2005, the scheme has awarded 57 million shares as options to its directors alone - of which all are still outstanding, according to its annual report for the financial year ended Dec 31, 2006.

These 57 million shares are equal to about 10 per cent of the 587.775 million shares LMA has issued - a sizeable proportion indeed. The estimated fair value of the options granted, that is, the stock compensation charge recorded in the company's books in 2006, amounted to US$1.5 million (S$2.2 million) - compared to its net income for the year of US$22.5 million.

Such a substantial share option grant will no doubt raise concerns among LMA's other shareholders as to the potential dilution of their stakes, when these options are exercised.

The life of these stock options was also recently extended - at an extraordinary general meeting in April last year - from seven years to 10 years, increasing the options' intrinsic value.

Investors should ask if LMA's generous executive share option plan will be tweaked to take into account the more modest financial performance the company is expected to rack up this year.

But perhaps a more compelling question is why LMA has chosen to grant such a large number of stock options to its independent directors?

Of the 57 million stock options granted to LMA's directors, 13.5 million options went to its three independent directors - David Wong, Chew Heng Ching and Lim Hock Beng. They each got 4.5 million options.

There's no doubt as to their contribution; but should a company's independent directors - whose very mandate is to remain independent, in order to safeguard the interests of stakeholders other than the majority shareholders - get such a large number of stock options, if at all?

There are those who believe that owning a stake in a company aligns one's interest to that of the company's. But the Enron and Worldcom sagas at the turn of the century have shown just how management and directors' objectives can deviate wildly from the company's, when they are heavily rewarded with stock options.

Also, unlike shareholders, the holders of stock options participate in the upside but have little downside risk; so, options don't necessarily align holders' interests with that of the company.

Independent directors

Furthermore, compensating independent directors with a large number of stock options threatens their very mandate to remain independent - and encourages them to be more focused on the short-term and volatile movements of a company's share price, which can also be manipulated.

For that reason, large corporations such as Samsung have refused to grant stock options to their independent directors - in order to maintain their independence.

In LMA's case, there's also the issue of its compensation committee - which decides on remuneration matters, including share option grants - being two-thirds made up of these independent directors.

Chew Heng Ching and Lim Hock Beng sit on LMA's compensation committee and, according to the company's annual report, 'determine specific remuneration packages for each executive director, as well as the granting of the share options in accordance with the rules of the company's executive share option scheme'.

The annual report adds that 'no director is involved in determining his own remuneration'. But even if Mr Chew and Mr Lim do not decide on their own rewards, investors should ask if it is necessarily the best practice for the independent directors to be deciding on the compensation for other independent directors.