Option Backdating Research Articles

CEO Stock Option Grants: The Economic Consequences of Revelation of Backdating and the Confounding Effect of Good-Timing of Earnings Disclosure

This paper examines the economic consequences of the revelation of CEO stock option backdating and the confounding effect of the good-timing of earnings disclosure in explaining the pattern in stock returns around option grant dates. First, we investigate 136 firms identified in the Wall Street Journal (WSJ) as of December 2006 as having been implicated in option backdating. Using the CRSP 2006-2007 data, we find that the economic loss upon the revelation of backdating is $129 billion and that it is significantly associated with the potential option expenses. Second, using a full sample from the Thomson Financial Insider Filing Database, we document that backdating and good-timing jointly existed in the full sample before the Sarbanes-Oxley Act of 2002 (SOX). Moreover, our evidence suggests that while the SOX mitigates the backdating problem, the trough pattern in stock returns around option grant dates in the post-SOX period is mainly driven by good-timing.

Stock Price Effects and Determinants of Option Backdating Probe Announcements

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.

Shock Options: The Stock Options Backdating Scandal of 2006 and the SEC's Response

This paper summarizes the recent stock options backdating scandal from the perspective of the Securities and Exchange Commission. The paper begins with a brief history of the stock options expensing debate. The paper continues with a discussion of the academic research that propelled the phenomenon of options backdating into the media and regulatory spotlight. The paper then examines three case studies of companies and executives charged by the Commission. The paper concludes with a brief analysis of the Commission's recent policy regarding company fines.

Recent Developments at the Securities and Exchange Commission: Academic Contributions and Opportunities

In recent years, the Securities and Exchange Commission (SEC) has grown in size and scope. The implementation of Sarbanes-Oxley (SOX) and the globalization of accounting standards have increased the SEC's workload and brought forth important questions regarding the development and application of accounting and auditing standard setting and regulation. This paper identifies key issues of importance to the SEC including record levels of restatements, SOX implementation, the backdating of stock options, increased use of fair-values in financial reporting, adoption of IFRS by numerous non-U.S. registrants, and foreign deregistration. The article highlights the contribution of academic research as it relates to SEC speeches and rulemaking, drawing upon experience of 2005–2006 SEC academic fellows.

Accounting Considerations and Tax Implications of Stock Option Backdating

Accounting Considerations and Tax Implications of Stock Option Backdating

Delaware Court of Chancery issues two important decisions on stock options backdating, spring‐loading and bullet‐dodging

PurposeThe purpose of this paper is to describe the implications of two recent decisions in Ryan v. Gifford and In Re Tyson Foods, Inc. concerning stock options backdating, “spring‐loading,” and “bullet‐dodging.”Design/methodology/approachThe paper summarizes the facts of the two cases, defines spring‐loading and bullet‐dodging, and explains how the court held in both cases that plaintiffs had sufficiently alleged demand futility, that directors of the two corporations had shown bad faith and breached their duty of loyalty, and that the doctrine of fraudulent concealment took precedence over the statute of limitations.FindingsThe paper finds that backdating of options is so egregious that board approval cannot meet the test of business judgment and there is a substantial likelihood of director liability. A director who intentionally uses inside knowledge not available to shareholders in order to enrich employees while avoiding shareholder‐imposed requirements cannot be said to be acting loyally and in good faith as a fiduciary. The best practice for companies is only to grant options that are in strict compliance with their shareholder‐approved option plans as well as applicable accounting, tax, and disclosure rules, and on either fixed‐in‐advance dates or when the companies' insiders would be free to trade.Originality/valueThe paper provides a thorough explanation of two of the most important court decisions to date on stock options backdating, spring‐loading, and bullet‐dodging.

Responsibility with authority: Using the power of the purse to leverage the effectiveness of the Board of Directors

A spate of recent scandals, from Enron to option backdating indicate that as a control mechanism, the Board of Directors is susceptible to failure in its governance role precisely because the board is often not thought of as a control mechanism to begin with. Our object in this paper is twofold: we first examine the stresses placed on boards from the increasing complexity of the firm, its transactions and the control environment. In particular, we introduce the critical issue of ‘control capture’ and propose a comprehensive control regime to overcome control capture. For a part time Board of Directors to be able to implement complex control systems requires that it makes use of the tool that other parties with oversight responsibilities utilise to translate their responsibility into authority: independent budgetary authority — the ‘power of the purse’— which allows the board to acquire credible means of exercising control and leveraging its effectiveness. We discuss the pros and cons of extending budgetary authority to the Board of Directors.

On the Use (and Abuse) of Stock Option Grants

Recently, a significant number of companies have come under public and regulatory scrutiny for backdating stock option grants. This article discusses factors that influenced the dramatic increase in stock option compensation and summarizes the academic research that led to the discovery of backdating. The information gained in this early stage of investigation provides some insight into the number of companies and potential costs of option backdating. Increased transparency and timely disclosure should curtail grant-date manipulation, but the credibility of the disclosure system requires active enforcement of the rules and standards. Investors need accurate, complete disclosures of executive compensation to hold boards of directors accountable for executive compensation.

Option Expensing and Executive Compensation

This paper examines the impact of mandatory option expensing on executive compensation. Although it merely changes the way option costs are disclosed (in footnotes or expensed in income statement), mandatory option expensing may actually alter the optimal contract between firms and their CEOs. We show theoretically that CEOs' perceived personal loss from option expensing reduces (increases) the optimal level of equity-based incentives (cash compensation). Our empirical analysis of CEO compensation using ExecuComp data supports this prediction. In addition, we find that equity incentives decline more sharply in firms that provided more excessive levels of performance pay than comparable firms do. We also find evidence that the fraction of incentives derived from stock options declines as firms comply or prepare to comply with mandatory option expensing, supporting a substitution effect between restricted stock and stock options. The documented impact of option expensing is robust to alternative explanations including the impact of the Sarbanes-Oxley Act of 2002, option backdating, different measures of equity incentives, regression specifications, and estimation methods.

The Impact of Regulatory Intervention in Stock Options Backdating Disclosures

Previous literature on the effects of disclosing options backdating problems focused mainly on estimating the cumulative and aggregate losses. This paper takes a different approach and investigates the effect of regulatory intervention on companies accused of backdating stock options. An event study approach is employed to analyze the announcements of backdating problems made by 83 companies. Our analysis shows that the companies under regulatory investigation suffered greater declines in value than companies who are not. However, the magnitude of the decline in value associated with outside investigation does not appear to be dependent on the timing of the regulatory intervention. In other words, no extra loss was incurred to those companies whose backdating problems were first exposed or triggered by regulatory action. Further analysis indicates that total loss in market value suffered by companies may reflect both the severity of the backdating problems and an extra cost imposed by regulatory investigations per se. Our preliminary estimate is that as much as one-third of the total loss may be attributable to regulatory involvement.

Stock option backdating bedlam

AbstractNow that the dust has settled a bit, we take a closer‐look at the recent stock option backdating scandal. Stock option plans have usually been justified by saying they aligned management's interests with those of shareholders. But the authors point out that by backdating stock options, the board of directors weakens the bond between top management and shareholders.What caused this latest financial scandal? Was it one more example of unbridled executive greed? Or was it mostly sloppy recordkeeping? This article examines the issues, and the future implications for companies. © 2007 Wiley Periodicals, Inc.

Capital Market Reactions to Option Backdating Probes

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 the actual grant dates are days, weeks, or months before or after their stated date. We investigate capital market reactions to backdating probe announcements for a sample of 180 implicated companies. 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.

The Economic Consequences of Revelation of Stock Option Backdating and the Confounding Effect of Good-Timing of Earnings Disclosure

The Economic Consequences of Revelation of Stock Option Backdating and the Confounding Effect of Good-Timing of Earnings Disclosure

Corporate Governance and Backdating of Executive Stock Options

This paper investigates whether weak corporate governance is a contributing factor to the incidence of backdating executive stock option awards. Based on a sample of S&P 1500 firms that exhibit evidence of backdating, we find that firms with weaker governance structures that allow CEOs to exercise greater power over the board and its compensation committee are more likely to engage in CEO option backdating. Moreover, the tendency to backdate is stronger when stock options are more important in CEO compensation and when directors receive option grants on the same date as the CEO. We also find interlocking boards among backdating firms are associated with a higher incidence of backdating. Finally, we find that CEOs of backdating firms receive a significantly higher level of total compensation than their counterparts in non-backdating firms after controlling for economic determinants of executive pay, and that the predicted excess compensation arising from the board and ownership structure variables has a more negative association with future firm performance for backdating firms relative to non-backdating firms. The evidence is consistent with backdating firms having greater agency problems that negatively affect shareholder value.

Some Observations on the Stock Option Backdating Scandal of 2006

The corporate stock option backdating scandal has dominated business page headlines during the summer of 2006. The SEC is currently investigating more than seventy-five companies with respect to the timing and pricing of stock options granted during the boom years of the late 1990s and early 2000s, and the number of firms caught up in the scandal seems to increase every day. This essay contributes to our understanding of the backdating phenomenon by analyzing the economics of backdating and the characteristics of the firms under investigation. Its main points are the following: First, given the high volatilities of the stocks of the technology companies that dominate the list of firms under investigation and the fact that options granted to executives and employees typically may not be exercised for several years, press reports that focus on the size of the strike price discounts achieved by backdating significantly overstate the value of backdating. In some cases, reducing the strike price by a dollar per share by backdating increased the Black-Scholes value of the option by less than twenty cents per share. Second, completely unnoticed in the discussion so far is the fact that in many cases backdating dramatically reduced the apparent value of options. Because the size of executive stock option grants often is determined first by establishing the value to be delivered and then by calculating the number of shares to be covered by the option, reducing the apparent value of option shares may have substantially increased the size and true economic value of backdated executive option grants. Third, comparison of semiconductor firms under investigation for backdating with peer companies that are not suggests an association between backdating and the use of options in compensating non-executive employees. This essay considers several explanations for backdating non-executive options, including share limitations, minimizing apparent rank and file compensation, and cognitive biases. Finally, this essay argues that the backdating phenomenon is really not an accounting scandal. Backdating has accounting consequences, but it is unlikely to have been accounting driven.

Option backdating: A reminder to keep the eye on the ball

Option backdating: A reminder to keep the eye on the ball

Timing Corporate Disclosures to Maximize Performance-Based Remuneration: A Case of Misaligned Incentives?

Timing of stock option grants has become a significant corporate governance issue, in the light of the SEC's on-going inquiry into back-dating of stock options. In this article, we examine the general problem of misalignment of interests arising from managerial discretion as to the timing and content of corporate disclosures in the context of performance-based compensation. We consider, and assess from a legal perspective, several empirical studies, which strongly suggest that CEOs are manipulating disclosure in such a way as to increase their own compensation. We argue that all but the most egregious forms of disclosure manipulation by management are either legally permissible or effectively insulated from legal redress. The article then examines the underlying rationales for the existence of broad managerial discretion over timing of disclosure under securities laws, and the extent to which possible misalignment of interests in the area of disclosure timing and performance-based pay can be reduced by governance mechanisms, such as improved board monitoring, structural changes to performance-based pay or enhanced enforcement of securities laws. We conclude that although each governance mechanism has a role to play, no single mechanism is likely to be a governance panacea.

The Reputational Penalty Firms Bear from Committing Criminal Fraud

Introduction Optimal penalties for corporate fraud require that firms face expected penalties equal to the total social costs of the crime. Yet formal courtimposed sanctions for committing fraud often represent a small fraction of the damage produced by the fraud. Sheer and Ho (1989), for example, estimate that the median and mean ratios of criminal fines to the private loss from private fraud were 0.14 and 0.73 in 1988. The corresponding median and mean ratios for government procurement fraud were 0.29 and 1.60. Including criminal restitution raises the median dollar sanction-to-loss ratio for private fraud to 0.84 and for government procurement fraud to 0.68. These ratios are for private parties convicted of fraud. The ratio of the expected court-imposed penalty to the social cost of the fraud is undoubtedly smaller. Particularly when compared to other crimes such as environmental pollution, where the median ratio of criminal fines to private loss is 3.71, the penalty for fraud seems surprisingly low. The perceived underpunishment of corporate frauds has recently affected public policy. Reflecting popular opinion that existing penalties were too low, the US Sentencing Commission – the federal agency responsible for setting the penalty guidelines used by judges – established corporate sentencing guidelines in 1991 that raised median corporate fraud penalties by over twentyfold. This article criticises the conventional wisdom about corporate fraud in two ways. First, we explain that the typical optimal criminal penalty for private corporate fraud is small because the external effects of such frauds are usually small. An increase in criminal penalties for corporate fraud can do more harm than good because it encourages the substitution of criminal penalties for reputation as a mechanism to police fraudulent behaviour.

Opting out of the Legal System: Extralegal Contractual Relations in the Diamond Industry

Opting out of the Legal System: Extralegal Contractual Relations in the Diamond Industry

Religiosity and Corporate Illegal Activity

This paper explores the effects of regional religiosity on the illegal financialactions of business executives. In particular, we examine the extent to which agencyand institutional theories may be used to explain fraudulent financial reporting andstock options backdating. Our findings indicate that religiosity has a negative influenceon illegal corporate activity but that this relationship is primarily limited to stockoptions backdating. Board size and independence are also shown to moderate therelationship between religiosity and illegal corporate activity. These results providesupport for an institutional theory perspective on mitigating executive opportunism.