Backdating of executive stock options

To test these theories, they examine the impact of the options awarded to the chief executives of some 950 American firms during 1993-2000.

This showed that the bigger the role played by share options in the boss's pay package, the more likely firms were to invest heavily in risky activities.

Attorney's Office in Northern California has launched a series of investigations and in July issued criminal and securities fraud charges against two top executives at Brocade Communications. National concern about the practice has been spurred by a series of articles in the Wall Street Journal. Companies found to have practiced this could be forced to restate their earnings.

District Attorney's Office has also issued several subpoenas in launching a criminal probe. The typical practice was to record a felicitously timed prior date as the grant date, such as the point when the stock had been at its lowest in recent months, instead of the date when the award was actually granted.

This, posit the authors, gives an incentive to take big bets, by investing in risky activities with long odds on a high pay-off.

They also posit that these bets will produce more extreme losses than extreme wins.

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(Backdating refers to retrospectively picking a favourable date to set the price of an option, when the firm's share price is at a low point, rather than using the price on the day the option is actually awarded.) He faces up to 20 years behind bars, unless the newly launched Friends of Greg Reyes campaign convinces the authorities that he has been the victim of a miscarriage of justice.Other companies, however, may have followed the same pattern without making these changes.Backdating is not per se illegal, but, under the Sarbanes-Oxley Act, top executives must report grants made to them within two days of the grant (before Sarbanes-Oxley, it was 45 days).It also confirmed that high levels of share options were associated with more extreme ups and downs in a firm's share price, and that the big downs significantly exceeded the extreme highs.The authors conclude that “not only does this asymmetry affect the selection of strategic initiatives, as we have discussed, but it may also cause CEOs to be inattuned to early signs of project failure and generally careless about risk mitigation.” Surely this is not the sort of motivational incentives that shareholders want. Nejat Seyhun of the University of Michigan for the newspaper showed that that options granting practices between 20 often failed to comply with the Sarbanes-Oxley requirement that grants of awards to executives be reported within two days of board approval (T"he Dating Game: Do Managers Designate Option Grant Dates to Increase Their Compensation? Prior research at Erik Lie at the University of Iowa found a pattern of probable options backdating in a number of companies prior to 2002.

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