Ethics of options pricing and backdating

Posted by / 27-Jan-2020 19:01

Ethics of options pricing and backdating

We use cookies to make interactions with our website easy and meaningful, to better understand the use of our services, and to tailor advertising.For further information, including about cookie settings, please read our Cookie Policy .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.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.The graph below shows the dramatic effect of this new requirement on the lag between the grant and filing dates.

(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.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.

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