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This made me think about the possibility that some of the grants had been backdated.I further found that the overall stock market performed worse than what is normal immediately before the grants and better than what is normal immediately after the grants.Remy Welling, a senior auditor at the IRS, was asked to sign the deal in late 2002.Instead, she decided to risk criminal prosecution by blowing the whistle.Unless corporate insiders can predict short-term movements in the stock market, my results provided further evidence in support of the backdating explanation.In a second study forthcoming in the Journal of Financial Economics (available at Randy Heron of Indiana University and I examined the stock price pattern around ESO grants before and after a new SEC requirement in August of 2002 that option grants must be reported within two business days.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.
An example illustrates the potential benefit of backdating to the recipient.
Furthermore, the pre-and post-grant price pattern has intensified over time (see graph below).
By the end of the 1990s, the aggregate price pattern had become so pronounced that I thought there was more to the story than just grants being timed before corporate insiders predicted stock prices to increase.
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.
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A 2004 NY Times article describes this case in greater detail (the article is available here), and so does a 2006 article in Tax Notes Magazine (available here).