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 reporters note that the chief financial officer of Broadcom urged that the options awards to executives be dated on December 24th.They then add: That sure is snide and sounds clever.It’s far more likely that the executives at Broadcom were going to receive total compensation packages worth a certain amount, and that dating the option grants earlier just allowed the company to issue fewer options.
Because the option value is higher if the exercise price is lower, executives prefer to be granted options when the stock price is at its lowest.
Additionally, companies can use backdating to produce greater executive incomes without having to report higher expenses to their shareholders, which can lower company earnings and/or cause the company to fall short of earnings predictions and public expectations.
Corporations, however, have defended the practice of stock option backdating with their legal right to issue options that are already in the money as they see fit, as well as the frequent occurrence in which a lengthy approval process is required.
In particular, failure to do so probably would constitute a material omission with respect to the executive compensation disclosures required in the proxy statement for the corporation’s annual meeting.
Truth on the Market finds the arguments against the practice less powerful.