Ethics of options pricing and backdating
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.
In particular, he found that stock prices tend to increase shortly after the grants.
He attributed most of this pattern to grant timing, whereby executives would be granted options before predicted price increases.
This made me think about the possibility that some of the grants had been backdated.
I further found that the overall stock market performed worse than what is normal immediately before the grants and better than what is normal immediately after the grants.
In comparison, had the options been granted at the year-end price when the decision to grant to options actually might have been made, the year-end intrinsic value would have been zero.
Backdating does not violate shareholder-approved option plans.
To the extent that companies comply with this new regulation, backdating should be greatly curbed.
However, under the new FAS 123R, the expense is based on the fair market value on the grant date, such that even at-the-money options have to be expensed.) Because backdating is typically not reflected properly in earnings, some companies that have recently admitted to backdating of options have restated earnings for past years. The exercise price affects the basis that is used for estimating both the company's compensation expense for tax purposes and any capital gain for the option recipient.
Thus, an artificially low exercise price might alter the tax payments for both the company and the option recipient.
Unless corporate insiders can predict short-term movements in the stock market, my results provided further evidence in support of the backdating explanation.