Positive news announcements after grants is consistent with both spring-loading and backdating. How do we know that backdating takes place in practice? Critics of backdating argue that the practice is difficult to detect and thus encourages boards and executives to use it to synthesize more creative compensation packages. In a follow-up story, I supplied the WSJ with data that allowed it to identify six companies as possible backdaters available here. 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.
The terms "spring loading" and "bullet dodging" refer to the practices of timing option grants to take place before expected good news or after expected bad news, respectively. Some of the more prominent corporate figures involved in the controversy currently are Steve Jobs and Michael Dell. For several years, Micrel allowed its employees to choose the lowest price for the stock within 30 days of receiving the options. The collective evidence suggests that these practices play a minor role in explaining the aggregate stock returns around grants. How do we know that backdating takes place in practice? Let's say Jane now decides to exercise her stock options. The board formally grants the stock options to John every year at its January board meeting. For example, there is evidence that exercises of options in which the acquired shares are i not sold have been backdated to low prices to minimize personal taxes and ii sold to the company have been backdated to high prices to maximize the proceeds from the share sales. Backdating can be hard to identify. The company would then grant the option but date it at or near its lowest point. Toward the other extreme, where the backdating was a result of overly informal internal procedures or even just delays in finalizing the paperwork documenting options grants, not intentional wrongdoing, there is likely to be no formal sanction—although the company may have to restate its financial statements to bring its accounting into compliance with applicable accounting rules. ESOs are usually granted at-the-money, i. In such a case, tax deductions would be denied. By the end of the s, the aggregate price pattern had become so pronounced that I thought there was more to the story than just grants being timed before corporate insiders predicted stock prices to increase. The SEC, the media, and the investment community will certainly uncover more cases in the near future. Annual and quarterly reports filed by the company did not include the compensation costs that stemmed from the options backdating incidents. I further found that the overall stock market performed worse than what is normal immediately before the grants and better than what is normal immediately after the grants. District Court for the Northern District of California. Options backdating occurs when a company grants an option that is dated prior to the date the company granted the option. For example, if spring-loading and bullet dodging played a major role, we should observe pronounced price decreases before grants and increases after grants irrespective of whether they are filed on time, but we don't. Under APB 25, the accounting rule that was in effect until , firms did not have to expense options at all unless they were in-the-money. An internal investigation uncovered 49 cases in which the reported date of a Mercury stock-option grant differed from the date on which the option appears to have been actually granted. Second, companies sometimes have a mix of option plans, some of which might dictate the grants to be scheduled in advance, in which case the overall evidence of backdating will be murky. Companies would simply wait for a period in which the company's stock price fell to a low and then moved higher within a two-month period. The practice sometimes also occurs in the insurance industry, whereby policy issuers make the effective date of a policy or claim earlier than the application date in order to obtain a lower premium for the customer or obtain better claim results. For instance, public companies generally grant stock options in accordance with a formal stock option plan approved by shareholders at an annual meeting.
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