Erik lie backdating study
Cases of backdating employee stock options have drawn public and media attention.According to a study by Erik Lie, a finance professor at the University of Iowa, more than 2,000 companies used options backdating in some form to reward their senior executives between 19.In 1972, a new revision (APB 25) in accounting rules resulted in the ability of any company to avoid having to report executive incomes as an expense to their shareholders if the income resulted from an issuance of “at the money” stock options.In essence, the revision enabled companies to increase executive compensation without informing their shareholders if the compensation was in the form of stock options contracts that would only become valuable if the underlying stock price were to increase at a later time.The SEC’s opinions regarding backdating and fraud were primarily due to the various tax rules that apply when issuing “in the money” stock options vs.
However, when granting options, the details of the grant must be disclosed, meaning that a company must clearly inform the investment community of the date that the option was granted and the exercise price. In addition, the company must also properly account for the expense of the options grant in their financials.
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.
Backdating allows executives to choose a past date when the market price was particularly low, thereby inflating the value of the options.
An example illustrates the potential benefit of backdating to the recipient.
Do you ever wish that you could turn back the hands of time?