Wednesday, July 19, 2006

Backdating of Executive Stock Options

In the just released report of Heron and Lie from Indiana University and the University of Iowa, the extent of the backdating or manipulation of option grants to top executives is estimated for the period of 1996-2005.

Their research prompted the Wall Street Journal to undertake research that identified dozens of suspect firms and at this point, at least 50 firms are being investigated by the SEC. Their study focused on unscheduled, at-the-money option grants, a total of 39,888 stock option grants to top executives. By granting options at-the-money, there are no tax implications for the executives at the time of the grant. If options are granted at prices in excess of the current market, there is little incentive to backdate.

The SEC had tightened reporting regulations on August 29, 2002 requiring executives to report stock option grants they received within two business days. For grants that were filed after this date, that were filed on a timely basis, the incidence of backdating was 7%. For grants filed late it was 19.9%! Even in 2005, only 87% of option grants are filed on time.

However, the period prior to August 2002 showed the egregious conduct of some managements. The authors estimate that 23% of unscheduled, at-the-money grants were backdated.

Grant manipulation was more prevalent among firms that are small, operate in the tech sector and have high stock volatility. Manipulation is more likely when large numbers of options are granted and there are numerous recipients.

The numbers are shocking. Here are the percentage of options that were backdated prior to August 2002:

Grants by low-tech firms...........................23.0%
Grants by high-tech firms.........................20.1%
Grants by small firms................................23.1%
Grants by medium firm.............................27.0%
Grants by large firms.................................15.4%
Grants by firms with low stock volatility....26.2%
Grants by firms with high stock volatility...29.0%

Post August 2002
Grants filed on time....................................7.0%
Grants filed late..........................................19.9%

Call me naive, but I am shocked and dismayed to see that 20% of current option grants are still subject to backdating.

4 Comments:

At 10:01 AM, Blogger Karna said...

Rick
I dont think the conclusion you can draw from the 20% is that they are backdating. There are other reasons - paperwork is arduous, filing approvals are cumbersome, internal controls are non existent. These are some reasons why companies even after SOX file their options grant information after the 2 day designated period.

Mukund
http://blog.vangal.com

 
At 4:57 PM, Blogger douglas mcintyre said...

Great post.

 
At 8:25 PM, Blogger Rick said...

Hi Mukund

As you see, based on this study's methodologies, among options that were filed in a timely (2 day) basis, some 7% of these timely reports showed evidence of backdating manipulation. Among the option grants that were filed on a late basis (after 2 days and in 2005, this still represented about 13% of all option grants), 20% of those (hence, 2.6% of all option grants) demonstrated evidence of backdating.

 
At 1:45 AM, Blogger Karna said...

Rick
Have you read this research piece on CEO compensation at top 100 companies and the correlation to performance. Its a must read.

http://blog.vangal.com/2006/07/20/must-read-article-that-is-tangential-research-from-dolmat-connell-partners.aspx

 

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