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Zynga's stock 'scandal'

November 10, 2011: 2:37 PM ET

What did I do?

There is no joy in Cityville -- the mighty Pincus was called a lout.

Zynga this morning woke up to a front-page story in the Wall Street Journal, accusing the social gaming company and its CEO Mark Pincus of strong-arming employees into giving up previously-granted stock options. It's a major black mark for Zynga, which expects to go public later this month. It's also misleading.

Before continuing, please understand that I am not accusing the WSJ of getting its facts wrong. Instead, I'm suggesting that it drew the wrong conclusions from those facts.

At issue here were stock option grants given to early Zynga employees. Most of the grants were designed to vest over a four-year period, which is fairly standard within Silicon Valley. So for each of your first four years at the company, 25% of your options convert into actual shares vest, thus giving you the opportunity to purchase actual shares. There is no promise as to what the shares may ultimately be worth, but start-up employees are an optimistic bunch that often left higher-salaried jobs with more established companies.

Once an employee's options vest, he or she is generally entitled to keep them whether or not they remain employees (although companies sometimes have the right to buy back stock at a pre-determined price). Unvested options disappear if an employee leaves -- either voluntarily or involuntarily.

At Zynga, however, Mark Pincus apparently likes to do things a bit differently. Rather than simply firing under-performing employees and handing unvested options over to the replacement, Pincus often likes to find another position within Zynga where the employee might still be able to contribute. But because that new position was often lower down the corporate totem poll, Pincus basically wanted to cut the person's compensation by reducing his or her number of unvested options (vested options were not touched).

As far as WSJ is concerned, this is a grievous abuse of power. By renegotiating, Pincus is breaking his word. And possibly the company's contractual obligations.

But this isn't Major League Baseball, where the Boston Red Sox are stuck paying Carl Crawford $20 million per year even if he proves no better than a backup. It's a non-unionized startup, where the CEO is well within his rights to simply fire an under-performing employee (and recover unvested options). In fact, that's what happens at most companies. The difference at Zynga is that Pincus seems intent on retaining talent, even if that talent either didn't live up to initial expectations or didn't adequately match up to the changing needs of a fast-growing company.

Since when are CEOs not allowed to decide certain employees are overpaid? Perhaps Pincus should have shown a bit more humility by giving up some of his own options under the theory that he was at faulty for the original hiring decision. But, from looking at Zynga's offering documents, liquidity doesn't really seem to be a major problem. For example, the company issued over 33 million in new stock options in 2010, according to regulatory filings. Pincus was not among the recipients.

In retrospect, however, Zynga could have avoided this entire mess. And I don't just mean by firing people instead of renegotiating with them. Instead, it could have tied some of its options to performance metrics rather than time metrics. This is a company that largely organizes itself by product group (i.e., Cityville team, Poker team, etc). Such products have easily-measured metrics, including revenue, users, frequency of use, etc. Why vest options just based on ongoing employment, when you could also include product-specific performance objectives? It's not terribly common, but neither is a 4-year-old company on pace for more than $1 billion in annual revenue.

But, again, that's Monday morning quarterbacking. What Zynga did may sound bad on newspaper, but is little more than morally-acceptable business as unusual.

Update: Fortune has obtained an email sent today by Pincus to Zynga employees, related to the WSJ story. Read it here.

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About This Author
Dan Primack
Dan Primack
Senior Editor, Fortune

Dan Primack joined Fortune.com in September 2010 to cover deals and dealmakers, from Wall Street to Sand Hill Road. Previously, Dan was an editor-at-large with Thomson Reuters, where he launched both peHUB.com and the peHUB Wire email service. In a past journalistic life, Dan ran a community paper in Roxbury, Massachusetts. He currently lives just outside of Boston.

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