Options backdating cases
Unfortunately, these conditions are rarely met, making backdating of grants illegal in most cases.(In fact, it can be argued that if these conditions hold, there is little reason to backdating options, because the firm can simply grant in-the-money options instead.)David Yermack of NYU was the first researcher to document some peculiar stock price patterns around ESO grants.Furthermore, the pre-and post-grant price pattern has intensified over time (see graph below).By the end of the 1990s, the aggregate price pattern had become so pronounced that I thought there was more to the story than just grants being timed before corporate insiders predicted stock prices to increase.
Thus, an artificially low exercise price might alter the tax payments for both the company and the option recipient.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.
Further, at-the-money options are considered performance-based compensation, and can therefore be deducted for tax purposes even if executives are paid in excess of $1 million (see Section 162(m) of the Internal Revenue Code).