Stock Price Effects and Determinants of Option Backdating Probe Announcements

Abstract

The pervasiveness of option backdating practices has resulted in broad regulatory scrutiny, formal investigations by federal authorities and internal inquiries by more than 200 implicated companies. Prior studies (Yermack 1997; Aboody and Kasznik 2000; Lie 2005; Heron and Lie 2006) find a pattern of timing of stock option grants to influence stock prices. Option backdating happens when grant dates are managed retroactively to precede a run-up in underlying shares in an attempt to maximize the option value. We investigate capital market reactions to backdating probe announcements for a sample of 180 implicated companies and the link between such reactions and specific firm attributes. We detect, on average, negative abnormal returns for implicated companies. We also find that the market reaction is more negative for companies that have higher stock price volatility, less effective corporate governance resulting in shareholder lawsuits or departure of their executives, and more leverage. These results have implications for public companies, policy makers, regulators, and the investing and academic communities, as more companies are being investigated by federal authorities and their corporate governance, financial reporting and management integrity are being scrutinized.