Stock option backdating restatements
This pioneering study was published in the Journal of Finance in 1997, and is definitely worth reading.
In a study that I started in 2003 and disseminated in the first half of 2004 and that was published in Management Science in May 2005 (available at I found that stock prices also tend to decrease before the grants.
ESOs are usually granted at-the-money, i.e., the exercise price of the options is set to equal the market price of the underlying stock on the grant date.
The number of shares subject to option was 250,000 and the exercise price was (the trough in the stock price graph below.) Given a year-end price of , the intrinsic value of the options at the end of the year was (-) x 250,000 = ,750,000.Most shareholder approved option plans prohibit in-the-money option grants (and thus, backdating to create in-the-money grants) by requiring that option exercise prices must be no less than the fair market value of the stock on the date when the grant decision is made. For example, because backdating is used to choose a grant date with a lower price than on the actual decision date, the options are effectively in-the-money on the decision date, and the reported earnings should be reduced for the fiscal year of the grant.(Under APB 25, the accounting rule that was in effect until 2005, firms did not have to expense options at all unless they were in-the-money.The graph below shows the dramatic effect of this new requirement on the lag between the grant and filing dates.To the extent that companies comply with this new regulation, backdating should be greatly curbed.
Backdating allows executives to choose a past date when the market price was particularly low, thereby inflating the value of the options.