Strategic Timing and Backdating of Executive Stock Option Exercises: Before and After the Sarbanes-Oxley Act

Abstract

This paper considers executive stock option exercise timing in light of the potential for backdating of exercise dates. I find that 29 (16) percent of executive option exercises were not associated with same-day disposition of shares before (after) the August 29, 2002, enactment of more restrictive SEC reporting requirements for insider transactions under the Sarbanes-Oxley Act. I interpret this as evidence executives often exercise options with the intention of holding the acquired shares for at least a year in order to qualify for long-term capital gains tax treatment on stock appreciation beyond the exercise date. Exercises accompanied by stock disposition are associated with a stock return peak, and exercises not accompanied by stock disposition are associated with a stock return trough. Further tests indicate that in the pre-Sarbanes-Oxley period executives timed exercises ex ante based on private information regardless of the stock disposition strategy, and they often backdated exercise dates when they held the acquired shares or disposed of shares back to the company only. In the post-Sarbanes-Oxley period, executives appear to have benefited through ex ante information timing only.