Do you ever wish that you could turn back the hands of time?
Some executives have, well, at least when it comes to their stock options. In order to lock in a profit on day one of an options grant, some executives simply backdate set the date to an earlier time than the actual grant date the exercise price of the options to a date when the stock was trading at a lower level.
This can often result in instantaneous profits! In this article, we'll explore what options backdating is and what it means for companies and their investors.
Most businesses or executives avoid options backdating; executives who receive stock options as part of their compensation, are given an exercise price that is equivalent to the closing stock price on the date the options grant is issued.
This means they must wait for the stock to appreciate before making any money.
Although it may appear shady, public companies can typically issue and price stock option grants as they see fit, but this will all depend on the terms and conditions of their stock option granting program. 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.
The facts cannot be made unclear or confusing. In addition, the company must also properly account for the expense of the options grant in their financials.
If the company sets the prices of the Option backdating and its implications meaning grant well below the market price, they will instantaneously generate an expense, which counts against income.
The backdating concern occurs when the company does not disclose the facts behind the dating of the option. In short, it is this failure to disclose - rather than the backdating process itself - that is the crux of the options backdating scandal.
To be clear, the majority of public companies handle their employee stock options programs in the traditional manner. That is, they grant their executives stock options with an exercise price or price at which the employee can purchase the common stock at a later date equivalent to the market price at the time of the option grant.
They also fully disclose this compensation to investors, and deduct the cost of issuing the options from their earnings as they are required to do under the Sarbanes-Oxley Act of But, there are also some companies out there that have bent the rules by both hiding the backdating from investors, and also failing to book the grant s as an expense against earnings. On the surface - at least compared to some of the other shenanigans executives have been accused of in the past - the options backdating scandal seems relatively innocuous.
But ultimately, it can to be quite costly to shareholders. Cost to Shareholders The biggest problem for most public companies will be the bad press they receive after an accusation of backdating is levied, and the resulting drop in investor confidence. While not quantifiable in terms of dollars and cents, in some cases, the damage to the company's reputation could be irreparable. Another potential ticking time bomb, is that many of the companies that are caught bending the rules will probably be required to restate their historical financials to reflect the costs associated with previous options grants.
In some cases, the amounts may be trivial. In others, the costs may be in the tens or even hundreds of millions of dollars.
In a worst-case scenario, bad press and restatements may be the least of a company's worries. In this litigious society, shareholders will almost certainly file a class-action lawsuit against the company for filing false earnings reports.