Option Backdating Research Articles

Social capital and managerial opportunism: Evidence from option backdating

AbstractSocial capital potentially influences corporate outcomes by reducing the likelihood of managerial self‐serving behavior. This expectation follows from the likelihood that the consequences of self‐serving behavior are severe for firms in high‐social‐capital areas. Thus, we employ a sample of firms that backdated option grants to examine these propositions. Accordingly, we find a negative and significant relation between social capital and the probability and magnitude of backdating. Furthermore, we find a positive and significant relation between social capital and likelihood, as well as between the speed of the termination of senior executives and board members following option backdating. Notably, we find evidence for the notion that community norms can influence corporate behavior by creating an environment where self‐serving or bad behavior has severe consequences.

Trust and Debt Contracting: Evidence From the Backdating Scandal

AbstractWe study the effect of trust on debt contracting. We find that, after the revelation of option backdating, borrowers that likely backdated their previous option grants pay higher interest rates on loans. This adverse effect is mitigated by CEO replacements. Results are similar for public debt, but only if a third party identified the backdaters. After the backdating revelation, firms that engaged in backdating increase their reliance on public debt, and those without access to the public debt market experience capital constraints.

The economic consequences of ceasing option backdating

The economic consequences of ceasing option backdating

Does Media Coverage Cause Meritorious Shareholder Litigation? Evidence from the Stock Option Backdating Scandal

This study examines the role of media coverage in meritorious shareholder litigation. Asserting a causal effect of the media on litigation is normally difficult because of the endogenous nature of media coverage. However, we use the Wall Street Journal’s coverage of stock option backdating to overcome these issues. Using a matched sample of firms with similar probabilities of backdating and related government investigations, we find consistent evidence of a causal relation between media coverage and meritorious litigation. We also find a negative abnormal market reaction to the articles and conduct a variety of analyses to show that it was the content of the articles, rather than the coverage itself, that resulted in litigation. Our results demonstrate that the media serves an important role in corporate accountability that both disincentivizes misconduct and holds firms accountable.

The SEC’s Deterrence Effect on Corporate Fraud

I estimate, using hand-collected data, a model of strategic corporate fraud that incorporates and quantifies firms' adjustments to fraud propensities in response to their expectations of regulators' information processing capacity. The findings are economically significant. With a one standard deviation change in different regulatory interventions, 10 to 58 additional fraudulent cases are committed each year. I exploit the 2005 option backdating scandal as an exogenous shock to regulatory attention, and find further support for both opportunism in fraud and the SEC's deterrence effect. Heterogeneity in fraud driven by executive incentives and firm complexity is documented.

Corruption Along Supply-Chain Networks

I study how the corporate corruption culture of foreign suppliers and customers influences the propensity and magnitude of financial misconducts of US corporations. Using the World Bank Corruption Control Index, I find that firms connected to customers( suppliers) from countries with higher corruption culture are more likely to engage in financial misconduct, earnings management, and option backdating. I find that both the selection channel, where US firms with weaker corporate governance choose customers( suppliers) with high corruption culture, and the propagation channel, where the corruption cultures of foreign customers and suppliers influence US firms, explain the magnitude of the effects.

Corporate, social, political connections and corporate governance: A review

Considering the important role of connections in corporate governance quality, this review paper has investigated the effectiveness of corporate, social, and political connections on corporate governance practices. In general, the findings of this research show that networking activities in various forms positively and negatively affect corporate governance practices. As far as corporate connections are concerned, there is no consensus on the relationship between interlocked boards and firm performance. Moreover, interlocking boards are positively associated with the propagation of some governance malpractices such as earnings manipulation and options backdating. Regarding social connections, the evidence provides contradictory results regarding the effects of social ties on CEO compensation and firm performance. Finally, as for political connections, the findings related to the impact of political connections on corporate decisions and firm value are mixed. Furthermore, politically connected firms pay lower taxes; have more access to credit markets; and enjoy governmental contracts. Additionally, in some cases, political ties are positively associated with corrupt activities

The economic consequences of ceasing option backdating

The economic consequences of ceasing option backdating

How Do Accounting Practices Spread? An Examination of Law Firm Networks and Stock Option Backdating

ABSTRACTWe hypothesize that one way accounting practices spread is through law firm connections. We investigate this prediction by examining companies that avoided reporting compensation expense by engaging in stock option backdating. We hypothesize that executives engaged in backdating because they were desensitized to its inappropriateness when they learned through their legal counsel that other companies were engaging in this practice. We identify backdating companies through backdating-related restatements of earnings. Using network analysis, we find that backdating companies are highly connected with other backdating companies via shared law firms. Logistic regressions reveal that the odds of a company backdating are 53 to 88 percent higher when its law firm has another client that backdates, and that law firm connections are incremental to board interlocks and geographic location. Finally, law firms with backdating clients have more other clients with “lucky” grants, suggesting that backdating spread to other companies, but only some restated.JEL Classifications: J33; K22; K42; L14; M41; M43; M45.

Executive Pay and Labor’s Shares: Unions and Corporate Governance from Enron to Dodd-Frank

AbstractThis article is an historical analysis of the U.S. labor movement’s shareholder activism during the 2000s, which was based on their pension-plan assets. During the previous decade, corporate governance had tilted to give shareholders greater voice in corporate decisions. The protagonists were public pension plans such as CalPERS. Come the 2000s, they were replaced by unions and union-influenced pension plans. Their agendas overlapped but union investors were distinctive in their use of shareholder activism to make companies more public-minded, raise labor’s organizing power, and challenge executive power by reliance not only on shareholder activism but also political activities. Labor’s signature issue was executive pay, which was a topic that that shareholder activists during the 1990s had avoided other than to push for stock-based pay. But three waves of corporate scandals during the following decade caused other shareholders to become skeptical of executive pay-setting methods. Union investors zeroed in on expensing and backdating of stock options, and fought for say on pay, the issue where they had the greatest impact. An interaction between private orderings and regulation now developed, whereby shareholder pay reforms found their way into law. With inequality a major social concern, unions repeatedly contrasted lofty executive pay to stagnant wages. Yet little was said about lofty payouts to shareholders, which may have been a more important driver of inequality than executive pay. The article ties corporate governance to larger social and political developments in the U.S., and to the labor movement, embedding corporate governance in historical context.

CEO Behavioral Integrity, Auditor Responses, and Firm Outcomes

ABSTRACT We investigate the audit fee response to CEO behavioral integrity (BI). BI refers to the perceived congruence between an individual's words and deeds (Simons 2002). Because low word-deed congruence should result in more explanations when communicating, we use variation in explanations beyond firm fundamentals and CEO-specific characteristics in more than 30,000 shareholder letters to serve as a linguistic-based proxy for CEO BI. We find that audit fees increase as BI decreases, but BI is not associated with financial misstatement or litigation. These findings are potentially consistent with auditors undertaking additional work in response to low BI, which, in turn, mitigates the risk of restatements and lawsuits. The likelihood of option backdating increases as BI decreases, consistent with the contention that auditors lacked incentives to prevent backdating. Finally, BI is increasing in future performance, which suggests that CEOs partially underpin the returns to high-integrity corporate cultures. JEL Classifications: J24; L25; M14; M41; M42. Data Availability: Proprietary data from KRW International cannot be shared because of the terms of a confidentiality agreement. All other data are available from the public sources cited in the text.

Revealing Corporate Financial Misreporting

ABSTRACTThis study examines how frequently firms restate when they materially misstate their financial statements using stock option backdating as the setting. Stock option backdating provides a unique opportunity to study this issue because it is possible to estimate misstatements with publicly available information to a high level of confidence, and the extensive media coverage of backdating notified boards of directors of the significant risk of misstatement. After identifying firms that materially misstated earnings due to stock option backdating with 95 percent (99 percent) probability, we find that only 11.5 percent (16.1 percent) of these firms subsequently restated. Restating firms are larger, have greater board independence, higher litigation risk and ROA, a lower market‐to‐book ratio, less discretionary accruals, and are more likely to have a CFO that was not involved in backdating. Restating firms are also more likely to disclose other adverse news, face securities litigation, and turn over the CFO than firms that appear to materially backdate but do not restate. Since nearly 9 of 10 firms failed to restate, our results give pause to researchers who use restatements as an indicator of misreporting, and to regulators who levy penalties on those who do self‐report.

Marrying Diversity and Independence in the Boardroom: Just How Far Have You Come, Baby?

Corporate governance reform, with its focus on agency costs, and corporate diversity, with its emphasis on social equity, would appear to have little common ground, other than the corporate setting. Both strands of reform, however, share an important goal: improved functioning of the corporation through more active decisionmaking by its board. The spectacle of boards asleep at the wheels of governance jarred Congress into action in the wake of the multibillion dollar Enron/Worldcom string of debacles. Despite massive regulatory changes in corporate governance mandated by Sarbanes-Oxley, however, skyrocketing executive compensation, backdating of options, and mis-reporting of financial statements continue to command the news. This article examines the theoretical and empirical basis for independence as a solution to director dereliction of monitoring duties, and posits that the lack of empirical support for independence may be due to a definitional quandary, and that defining independence as mere absence of financial conflicts rather than diversity of opinion may be the root of the problem. This article takes an interdisciplinary approach to accountability of large publicly held corporations, using economics and cognitive insights into human rationality to assess the role of law in structuring human interactions - in this case focusing on the decision making processes of directors of large publicly held corporations. In particular, this article examines the Sarbanes-Oxley Act's corporate governance solution of emphasizing the role of independent directors in the firm. This article further explores the psychology of small group dynamics, examines the inherent problems of homogeneous groups, and suggests ways in which diversity of opinion mitigates the effects of small group dynamics. My article recognizes that the trust fostered by homogeneity has the dark side of quashing dissent, and suggests ways to overcome resistance to diversity. This article concludes that nourishing a culture of dissent is the foundation for the kind of decisionmaking that leads to effective monitoring, and that while gender and ethnic diversity are no guarantors of diverse viewpoints, they are a good place to start in creating the kind of board culture that will begin to take its monitoring duties seriously.

Drilled to obey? Ex‐military CEOs and financial misconduct

Research Summary: We examine the influence of CEOs' military background on financial misconduct using two distinctive datasets. First, we make use of accounting and auditing enforcement releases (AAER) issued by the U.S. Securities and Exchange Commission (SEC), which contain intentional and substantial cases of financial fraud. Second, we use a dataset of “lucky grants,” which provide a measure of the likelihood of grant dates of CEOs' stock options having been manipulated. Results for both datasets indicate that CEOs who served in the military are less inclined to be involved in fraudulent financial reporting and to backdate stock options. In addition, we find that these relationships are moderated by board oversight (CEO duality and independent directors in the board).Managerial Summary: CEOs who formerly served in the U.S. military are prevalent among U.S. firms. The military puts strong emphasis on the obedience of its personnel. In this study, we test if time spent in the military leads individuals to be more obedient to rules and regulations in the years after they have left the military and become CEOs. Our findings strongly suggest that CEOs who served in the U.S. military are less likely to be involved in financial misconduct. We also find evidence that tougher board oversight strengthens this relationship. Our findings have implications for regulators, auditors, practitioners, and researchers who are interested in determinants of and mechanisms to prevent fraud and stock option backdating.

Option Backdating Announcements and Information Advantage of Institutional Investors

This article uses transaction-level fund trading data from the United States to study the information advantage of institutional investors. Our research design follows a two-step procedure. In the first step, we identify funds that sell shares in firms before their unexpected revelation of stock option backdating (BD) investigations, and thus establish fund–firm pairs of interest. In the second step, we focus on trading that takes place at other times and find that the funds are more likely to make correct trades before the earnings announcements of their paired firms and that their trading performance for paired firms is better in general. This superior performance, however, is more evident in the pre-BD-announcement period and for firms whose BD investigations are initiated internally. The results imply that although institutions have access to private information on certain firms, this advantage disappears after the BD revelation, possibly due to reduced information leakage.

Backdating of executive stock options: comparing financial and nonfinancial industries

PurposeThe 2008-2009 subprime mortgage crisis in the USA caused bankruptcies and closures of many financial institutions. Yet many CEOs of US financial institutions were awarded huge bonuses and pay packages despite the economic collapse, suggesting that their incomes were not in conjunction with those of the shareholders, indicating a serious agency problem. This issue raises the question as to whether stock option backdating, another example of an agency problem, was as prevalent as slack lending policies among these financial institutions. This paper aims to compare the relative magnitude of executive option backdating in financial and nonfinancial firms.Design/methodology/approachUsing a sample of CEO stock option grants from 1995 to 2006, obtained from ExecuComp, the authors employ an event study around the grant dates of executive options. The authors compare the abnormal price movements between financial and nonfinancial firms.FindingsThe abnormal negative stock returns were found before the award dates for both groups of firms. The after-event abnormal returns of both groups of firms, however, show different trends. For nonfinancial firms, there is an immediate turnaround of the abnormal return movement right after the grants; that is, the price increases, indicating the occurrence of significant backdating events. For financial firms, however, there is no significant price rebound after the grant date. In fact, the price continued to decline throughout the after-event period.Research limitations/implicationsThe result shows that nonfinancial firms demonstrate significantly more option backdating behavior than financial firms.Practical implicationsThe findings suggest that previous findings on prevalent backdating among all public listed firms are only partially correct. This paper shows that backdating behavior found in previous studies is indeed driven by nonfinancial firms. This unexpected finding contradicts the initial prediction of authors that option backdating may be more likely among financial firms.Originality/valueBased on previous research, the authors recognize that generally the official grant dates of firms must have been set retroactively, as shown by Lie (2005). The findings, however, show that financial firms demonstrate only partial backdating behavior. This study opens a path for future research to further discover why financial firms exhibit less backdating behavior compared with nonfinancial firms, and if option backdating is not an issue for financial firms, why the share prices of these firms decline significantly prior to the grant date.

Hedge Fund Activism in the Corporate Bond Market: Evidence from Bondholderss Responses to Delay in Financial Reporting

We investigate hedge fund activism in the corporate bond market. The empirical setting we use is the active enforcement of bondholders’ rights during 2003-07 triggered by issuers’ violation of a standard bond covenant requiring timely financial reporting. Specifically, we examine differences in target company characteristics, strategic trading behavior, and subsequent outcomes between hedge-fund-involved and non-hedge-fund-involved interventions. We find that hedge-fund-involved interventions are more likely to target companies with higher levels of cash holdings, but less likely to target companies with a higher bankruptcy probability and greater amount of private debt outstanding. Meanwhile, the late filers in hedge-fund-involved interventions are more likely to have liquid bonds and their later filings are more likely to be predicted (e.g., triggered by option backdating investigations). The empirical evidence from strategic trading and market reactions suggests that hedge-fund-involved interventions are associated with elevated bond trading frequency before late filing notifications and a wealth transfer from stockholders and non-intervening bondholders to intervening bondholders. However these results are not present for non-hedge-fund-involved interventions. Taken together, the empirical evidence suggests that hedge fund activism in the corporate bond market is primarily driven by short-term profit consideration.

DO SCANDALS TRIGGER GOVERNANCE CHANGES? EVIDENCE FROM OPTION BACKDATING

AbstractWe examine whether firms charged with backdating option grants make discernible changes to board structure and activity and whether such changes help recoup value losses from the revelation of option backdating. We find that these firms increased board size, reduced duality, and increased board independence. In addition, the boards and the compensation committees of these firms experienced significant increases in meeting frequency. We also find that firms in the same sectors that had not been identified as backdating option grants experienced similar changes in board activity and some elements of board structure. Additional analysis reveals that increases in board size, chief excutive officer turnover, and the meeting frequency of the audit committee are related to buy‐and‐hold abnormal returns in the postscandal period.

The Effect of the Options Backdating Scandal on the Stock-Price Performance of 110 Accused Companies

Since academic scholars and the Wall Street Journal reported widespread evidence indicating that option grants to executives were backdated, an avalanche of news stories followed documenting this ever-widening corporate scandal. In this study we ask: How do disclosures of backdating affect shareholder value? We closely examine 110 companies listed in the Wall Street Journal's Perfect Payday webpage, collecting all news stories related to options backdating. We find that shareholders of these 110 companies suffer on average significant stock-price declines, ranging between 20% and 50%. Moreover, these losses do not seem to be due to temporary overreactions (at least so far). The negative 20% abnormal return translates into total dollar losses of well over $100 billion. The negative 50% abnormal return translates to approximately one-quarter trillion dollars of lost shareholder value. There is no evidence that this decline is driven by temporary overreaction, judging by the average performance of these 110 companies over a nearly 2 year period. We are aware of no analysts, scholars or commentators predicting that such massive losses in shareholder value would result from options backdating problems.

Do Executive Departures to Signal the End of a Scandal Create or Reduce Uncertainty? An Examination of Market Reaction in Stock Option Backdating Scandal Events

This study examines events at the conclusion of the 2006 stock option backdating scandal: the departures of C-level executives from firms implicated in backdating. The authors ask whether removing ...