Abstract
Previous research provides evidence linking equity pay to stock price manipulation. In this paper, we examine the vulnerability of different types of equity grants to stock price manipulation, both at the time of the equity award (front-end gaming) and at the unwinding of the equity holdings (back-end gaming). We find that all equity grants are susceptible to gaming but the level of vulnerability varies substantially. Front-end gaming is easily preventable if firms award equity grants with pre-specified terms for their equity grants (e.g., exercise price and number of shares) instead of letting the stock market to set them. In contrast, back-end gaming is more difficult to stop since executives have more flexibility in timing the unwinding of their equity holdings. While traditional and indexed stock options are the most vulnerable to back-end gaming, Asian stock options are the least. A simple solution to combat back-end gaming is thus to restructure equity grants and make their payoff dependent on average stock prices. Although the averaging period needs not be the entire life of the equity grant, it must be as least twice as long as the length of time executives may manipulate the stock price in order to be effective against back-end gaming.
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