Backdating scandal

Thus, if backdating explains the stock price pattern around option grants, the price pattern should diminish following the new regulation.

The graph below shows the dramatic effect of this new requirement on the lag between the grant and filing dates.To the extent that companies comply with this new regulation, backdating should be greatly curbed.ESOs are usually granted at-the-money, i.e., the exercise price of the options is set to equal the market price of the underlying stock on the grant date.Because the option value is higher if the exercise price is lower, executives prefer to be granted options when the stock price is at its lowest.Further, at-the-money options are considered performance-based compensation, and can therefore be deducted for tax purposes even if executives are paid in excess of

The graph below shows the dramatic effect of this new requirement on the lag between the grant and filing dates.

To the extent that companies comply with this new regulation, backdating should be greatly curbed.

ESOs are usually granted at-the-money, i.e., the exercise price of the options is set to equal the market price of the underlying stock on the grant date.

Because the option value is higher if the exercise price is lower, executives prefer to be granted options when the stock price is at its lowest.

Further, at-the-money options are considered performance-based compensation, and can therefore be deducted for tax purposes even if executives are paid in excess of $1 million (see Section 162(m) of the Internal Revenue Code).

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The graph below shows the dramatic effect of this new requirement on the lag between the grant and filing dates.To the extent that companies comply with this new regulation, backdating should be greatly curbed.ESOs are usually granted at-the-money, i.e., the exercise price of the options is set to equal the market price of the underlying stock on the grant date.Because the option value is higher if the exercise price is lower, executives prefer to be granted options when the stock price is at its lowest.Further, at-the-money options are considered performance-based compensation, and can therefore be deducted for tax purposes even if executives are paid in excess of $1 million (see Section 162(m) of the Internal Revenue Code).

million (see Section 162(m) of the Internal Revenue Code).

However, if the options were effectively in-the-money on the decision date, they might not qualify for such tax deductions.

There is also some relatively early anecdotal evidence of backdating.

A particularly interesting example is that of Micrel Inc.

Most shareholder approved option plans prohibit in-the-money option grants (and thus, backdating to create in-the-money grants) by requiring that option exercise prices must be no less than the fair market value of the stock on the date when the grant decision is made. For example, because backdating is used to choose a grant date with a lower price than on the actual decision date, the options are effectively in-the-money on the decision date, and the reported earnings should be reduced for the fiscal year of the grant.

(Under APB 25, the accounting rule that was in effect until 2005, firms did not have to expense options at all unless they were in-the-money.

The Wall Street Journal (see discussion of article below) pointed out a CEO option grant dated October 1998.