Tuesday, August 28, 2007
David I. Walker (Boston University) has published Unpacking Backdating: Economic Analysis and Observations on the Stock Option Scandal, 87 B.U. L. Rev. 561 (2007). Here is the abstract:
The corporate stock option backdating scandal has dominated business page headlines since the summer of 2006. The SEC has launched investigations of more than one hundred companies with respect to the timing and pricing of stock options granted during the boom years of the late 1990s and early 2000s, and the number of firms caught up in the scandal continues to increase. This Article contributes to our understanding of the backdating phenomenon by analyzing the economics of backdating and the characteristics of the firms under investigation. Its main points are the following: First, given the high volatilities of the stocks of the technology companies that dominate the list of firms under investigation and the fact that options granted to executives and employees typically may not be exercised for several years, press reports that focus on the size of the strike price “discounts” achieved by backdating significantly overstate the impact on the value per share of backdated options. In some cases, reducing the strike price by a dollar per share by backdating increased the Black-Scholes value of the option by less than twenty cents per share. Second, backdating dramatically reduced the apparent value of options, which reduced the total level of executive compensation reported to shareholders. However, because the size of executive stock option grants often is determined by first establishing the value to be delivered and then “backing into” the number of shares to be covered by the option, reducing the apparent value of option shares may have substantially increased the size and economic value of some backdated executive option grants. Third, comparison of semiconductor firms under investigation for backdating with peer companies that are not suggests an association between backdating and the use of options in compensating non-executive employees. This Article considers the effects of and several possible explanations for backdating non-executive options, including reducing apparent rank and file compensation. Finally, this Article argues that the backdating phenomenon is not an accounting scandal. Backdating has accounting consequences, but it is unlikely to have been accounting driven.